how to prepare innovative feasibility study in transitional economy

Preparing Feasibility StudyPreparing Feasibility Study

ByByKhaled Ayesh, MBA Khaled Ayesh, MBA

World Bank, InfoDev-funded Business World Bank, InfoDev-funded Business and IT Incubator, and IT Incubator,

Islamic University, GazaIslamic University, Gaza

Training OutlineTraining Outline• Definitions/introductionDefinitions/introduction • Purpose of preparing feasibilitiesPurpose of preparing feasibilities• Component of the feasibility studyComponent of the feasibility study• How to prepare a feasibility studyHow to prepare a feasibility study• How to analyze the investment climateHow to analyze the investment climate• How to figure out external business opportunitiesHow to figure out external business opportunities• Marketing studyMarketing study• Technical studyTechnical study• Financial studyFinancial study• Financial analysis/statements/ratiosFinancial analysis/statements/ratios• Environmental Impact studyEnvironmental Impact study• Cost and benefits analysisCost and benefits analysis• How to evaluate an investment projectsHow to evaluate an investment projects• Payback periodPayback period• Net present value/Discounted cash flowsNet present value/Discounted cash flows• Internal rate of returnInternal rate of return

Definition of feasibility Definition of feasibility studystudy

is a comprehensive study that is a comprehensive study that examine the examine the viability viability of an ideaof an idea that has a that has a business potentialbusiness potential and and advanced to a stage where the advanced to a stage where the prospective project is prospective project is socially socially responsibleresponsible, , commercially viable commercially viable and feasible business and feasible business opportunity exitopportunity exit..

A FRAMEWORK FOR NEW VENTURE CREATION

Entrepreneur

Innovative Idea

Market Opportunity

Venture Concept

Test ofPotential•Prove viability•Create initial “prospectus” to seek resources

Test ofFeasibility•Prove feasibility•Prepare for implementation•Gather resources

New Venture

Resources I•“Viability” Info (general market, process, org., etc.)•“Sweat” Equity

Resources II•“Feasibility” Info (specific market, process, org., etc.)•Initial Equity

Resources III•Prop., Plant & Eqmt•Personnel•Management•Buyers•Suppliers•Advisors/Partners•Full Debt & Equity

Policy Environment

Industry and Market Environment

The Purpose of feasibility The Purpose of feasibility studystudy

• For Startups micro project;For Startups micro project;

• New established small business; New established small business;

• Expanding existing businesses;Expanding existing businesses;

• Testing the technical viability, financial Testing the technical viability, financial viability, market viability. viability, market viability.

• Developing new product/service, Developing new product/service,

• Advocating the project with key Advocating the project with key governmental body, donor agency financing,governmental body, donor agency financing,

• Selling the project for further local Selling the project for further local ownerships.ownerships.

Sources of Investment Sources of Investment OpportunitiesOpportunities

• Screening innovative ideasScreening innovative ideas

• Reviewing country importing itemsReviewing country importing items

• Assessing local community needs of public Assessing local community needs of public services: education, health, infrastructure, etc.services: education, health, infrastructure, etc.

• Projecting future demands on certain products Projecting future demands on certain products and servicesand services

• Examining current diversified industrial trendsExamining current diversified industrial trends

• Reviewing available skilled and workforceReviewing available skilled and workforce

• Participating in international trade fairs/showsParticipating in international trade fairs/shows

• Market intelligence studies/experts researchesMarket intelligence studies/experts researches

Pre-feasibility studyPre-feasibility study

1.1. Describing a Product or serviceDescribing a Product or service

2.2. Describing market supply and demandsDescribing market supply and demands

3.3. Describing Production methodologiesDescribing Production methodologies

4.4. Describing initial inputs and Describing initial inputs and infrastructure supporting services.infrastructure supporting services.

5.5. Selecting the right location/placeSelecting the right location/place

6.6. Estimating Capital and operational Estimating Capital and operational costscosts

7.7. Estimating sales/revenues and profitEstimating sales/revenues and profit

1. Describing Product or 1. Describing Product or serviceservice• Describing product or services Describing product or services

characteristicscharacteristics

• Quality componentQuality component

• Physical shapePhysical shape

• Product features/benefits/adding Product features/benefits/adding valuevalue

• Ingredients/formulaIngredients/formula

• Describe competing productDescribe competing product

• Describe other product SubstitutesDescribe other product Substitutes

2. Describing market2. Describing market• Where is the product produced?Where is the product produced?

• What is the number of similar factory or What is the number of similar factory or providers of this type of product and in providers of this type of product and in what capacities?what capacities?

• Estimating the current and future Estimating the current and future consumption pattern.consumption pattern.

• Any incentives provided by governmentAny incentives provided by government

• Reviewing to GDP/Export/Import Reviewing to GDP/Export/Import lists/market shares.lists/market shares.

• Projection of market supply vs. demandProjection of market supply vs. demand

• Similar product prices and substitute pricesSimilar product prices and substitute prices

3. Describing Production 3. Describing Production methodologiesmethodologies

• Describing production processesDescribing production processes• Describing the type and kind of Describing the type and kind of

equipment, technical methodologies, etc.equipment, technical methodologies, etc.• Explaining the technology used, skilled Explaining the technology used, skilled

labor needed, quality control measures,labor needed, quality control measures,• Process engineering, drawings, technical Process engineering, drawings, technical

flow chart, flow chart, • The type of maintenance and specialized The type of maintenance and specialized

knowledge of techniciansknowledge of technicians• The sources and estimate the cost of The sources and estimate the cost of

machines, equipment, automation machines, equipment, automation providersproviders

• Piloting and testing of the prototype, Piloting and testing of the prototype, formula, product in the market.formula, product in the market.

4. Describing initial inputs and 4. Describing initial inputs and infrastructure supporting infrastructure supporting

servicesservices• Availability of inputs of raw materialsAvailability of inputs of raw materials• Infrastructure services of roads, sewage, Infrastructure services of roads, sewage,

water, electricity, cleaning disposals, etc.water, electricity, cleaning disposals, etc.• Availability of good relationships with main Availability of good relationships with main

suppliers.suppliers.• Governmental support and tax benefit Governmental support and tax benefit

bracketsbrackets• Industrial zone, business support Industrial zone, business support

centers/incubators.centers/incubators.• Bank financingsBank financings• Other supporting industry: packaging, Other supporting industry: packaging,

marketing, logistics, trade facilitation, marketing, logistics, trade facilitation, technology, etc.technology, etc.

5. Selecting the right 5. Selecting the right location/placelocation/place

• Access to marketAccess to market

• Strategic location fitnessStrategic location fitness

• Exhibition showsExhibition shows

• Access to industrial support facilitiesAccess to industrial support facilities

• Access to public infrastructure Access to public infrastructure servicesservices

• Environment friendly locationEnvironment friendly location

• Socially respected locationSocially respected location

• Community outreach comfortCommunity outreach comfort

6. Estimating Capital & operational 6. Estimating Capital & operational costscosts

• Estimating the costs of fixed assets:Estimating the costs of fixed assets:• Land, factory building, Land, factory building, • Capital Machinery, equipment, furniture Capital Machinery, equipment, furniture

and fixtures.and fixtures.• Current assets of stocks, inventory, Current assets of stocks, inventory, • Estimating the costs of running Estimating the costs of running

expenses:expenses:• Salaries for staff, overhead utilities, rent, Salaries for staff, overhead utilities, rent,

electricity, communications, water, fuel, electricity, communications, water, fuel, maintenance, labor, distribution, maintenance, labor, distribution, advertisement, transportation, etc.advertisement, transportation, etc.

7. Estimating Revenues and 7. Estimating Revenues and ProfitProfit

• Projection of Total annual salesProjection of Total annual sales• Projection of cost of goods soldProjection of cost of goods sold• Projection of overhead, Projection of overhead,

administrative and variable expensesadministrative and variable expenses• Projection of the profit marginProjection of the profit margin• Total Sales – Cost of Goods Sold = Total Sales – Cost of Goods Sold =

Gross ProfitGross Profit• Gross Profit – Overhead, admin, Gross Profit – Overhead, admin,

variable expenses = Profitvariable expenses = Profit

Writing ExerciseWriting Exercise

• Work in Group of 5 personWork in Group of 5 person

• Review the success storiesReview the success stories– الالحم : الدجاج تربية مشروع قصة الالحم : أوال الدجاج تربية مشروع قصة أوال– أبقار: حليب إنتاج مشروع قصة أبقار: ثالثا8 حليب إنتاج مشروع قصة ثالثا8

• Chose a business opportunityChose a business opportunity

• Start writing the following pre-feasibility Start writing the following pre-feasibility study key section:study key section:

Case study-Pre-feasibility study Case study-Pre-feasibility study formatformat

1.1. Description of a product/serviceDescription of a product/service2.2. Description of the marketDescription of the market3.3. Description of production methodologies Description of production methodologies

and technology usedand technology used4.4. Description of available infrastructure Description of available infrastructure

supporting servicessupporting services5.5. Description of the needed labors and Description of the needed labors and

skilled workersskilled workers6.6. Description of cost estimates: Capital and Description of cost estimates: Capital and

operating expendituresoperating expenditures7.7. Projection to revenues and profitsProjection to revenues and profits

Second Training DaySecond Training Day

Preparing feasibility studyPreparing feasibility study

Why Complete A Feasibility Why Complete A Feasibility Study?Study?

A comprehensive feasibility study A comprehensive feasibility study allows the user toallows the user to

• Determine if a market for a product Determine if a market for a product existsexists

• Develop and describe the production Develop and describe the production processes requiredprocesses required

• Determine the costs associated with Determine the costs associated with producing the productproducing the product

• Determine if the enterprise is Determine if the enterprise is profitable!profitable!

1. Marketing Study1. Marketing Study• Market analysis of the a Market analysis of the a

product/serviceproduct/service

• Description of the production capacityDescription of the production capacity

• Projection of the demand on this Projection of the demand on this product/serviceproduct/service

• Estimating the future Estimating the future demands/supply/imports/exports on demands/supply/imports/exports on certain product/servicecertain product/service

• Analyze the competition and major Analyze the competition and major competitorscompetitors

Determine Your MarketDetermine Your Market

• This is the most difficult part This is the most difficult part

• Should be divided into seven key partsShould be divided into seven key parts1.1. ConsumptionConsumption

2.2. MarketsMarkets

3.3. Distribution systemDistribution system

4.4. Market entryMarket entry

5.5. BuyersBuyers

6.6. Selling ArrangementsSelling Arrangements

7.7. PricesPrices

1.1. ConsumptionConsumption• What is the current consumption of What is the current consumption of

the product or service?the product or service?

• What are the current trends in What are the current trends in consumption? Is consumption consumption? Is consumption increasing or decreasing?increasing or decreasing?

• How is the product or service being How is the product or service being consumed? (Packaging, volumes)consumed? (Packaging, volumes)

1.1. Consumption… cont.Consumption… cont.• What is the quality of the product that What is the quality of the product that

is being consumed? is being consumed?

• Who consumes the product? What Who consumes the product? What are their demographics? (Age, income, are their demographics? (Age, income, educational levels, marital status, educational levels, marital status, family size)family size)

• Are these demographic segments Are these demographic segments growing or shrinking?growing or shrinking?

2.2. MarketsMarkets

• What is the current structure of the What is the current structure of the marketplace?marketplace?

• Who is currently supplying these Who is currently supplying these products to customers?products to customers?

• What will be the reaction of these firms What will be the reaction of these firms if a new firm enters the market?if a new firm enters the market?

• Can a firm compete with existing firms Can a firm compete with existing firms or other potential entrants?or other potential entrants?

2.2. Markets ……cont.Markets ……cont.• What are the implications for a firm What are the implications for a firm

who wants to expand its market?who wants to expand its market?– What are the costs?What are the costs?– What revenues can be expected?What revenues can be expected?

• Where are the markets (customers) Where are the markets (customers) located? Are they local, regional, located? Are they local, regional, national, or international? What will it national, or international? What will it cost to serve them?cost to serve them?

3.3. Distribution SystemDistribution System

• Will it be necessary to provide delivery Will it be necessary to provide delivery services?services?

• What delivery schedules will be What delivery schedules will be required?required?

• What common carrier options are What common carrier options are available?available?

• Should the firm provide delivery itself?Should the firm provide delivery itself?

• Should delivery equipment be Should delivery equipment be purchased or leased?purchased or leased?

4.4. Market EntryMarket Entry

• How will the product or service be How will the product or service be introduced to the market?introduced to the market?

• Will the product be marketed under Will the product be marketed under the company’s name or under some the company’s name or under some other name?other name?

• What will attract buyers? (Low prices, What will attract buyers? (Low prices, advertising, promotion, customer advertising, promotion, customer service, or some other method)service, or some other method)

5.5. BuyersBuyers

• Will you sell directly to consumers or Will you sell directly to consumers or go through a “middleman” buyer?go through a “middleman” buyer?

• What types of buyers will purchase What types of buyers will purchase the product?the product?

• Where are they located?Where are they located?

• What product specifications will they What product specifications will they require?require?

5.5. Buyers ……cont.Buyers ……cont.

• Have potential buyers expressed an Have potential buyers expressed an interest in the product?interest in the product?

• What type of purchasing What type of purchasing commitments are buyers willing to commitments are buyers willing to make?make?

• How reliable are the buyers?How reliable are the buyers?

• What type of payment schedules will What type of payment schedules will be encountered? How severely will be encountered? How severely will this affect the firm’s cash position?this affect the firm’s cash position?

6.6. Selling ArrangementsSelling Arrangements

• What type of selling services will you What type of selling services will you need to provide?need to provide?

• Will you need to employ a sales force Will you need to employ a sales force or go through a buyer?or go through a buyer?

• If you employ a sales force, how If you employ a sales force, how many people will this require? What many people will this require? What is their compensation plan?is their compensation plan?

6.6. Selling Arrangements Selling Arrangements ….cont.….cont.• How will they be selling the product? How will they be selling the product?

• What are the costs of these What are the costs of these activities?activities?

• Should you have sales offices located Should you have sales offices located throughout your geographic market throughout your geographic market area?area?

• Why have you chosen one method of Why have you chosen one method of selling activities over another?selling activities over another?

7.7. PricesPrices

• Setting a price is a critical activity in Setting a price is a critical activity in the market portion of the study.the market portion of the study.

• The price must be high enough to The price must be high enough to cover all costs and provide you a cover all costs and provide you a profit, but low enough that profit, but low enough that customers will purchase the product customers will purchase the product or service.or service.

7.7. Prices ………contPrices ………cont

• To To helphelp determine the price, look at: determine the price, look at:– Past prices of the industryPast prices of the industry– Current price trendsCurrent price trends– Expectations of buyers (brokers)Expectations of buyers (brokers)– Expectations of consumersExpectations of consumers– Quality levels of substitutes or Quality levels of substitutes or

competitorscompetitors

• These factors only help you set a These factors only help you set a price. They can’t set the price for youprice. They can’t set the price for you

Consider price elasticity of demand before Consider price elasticity of demand before changingchanging pricesprices

Quantity

Price

$

Quantity

Price

$

10050

$10

$12

(100 * $10) - (50 * $12) = $1000 - $600 = 400 loss

10080

$10

$20

(100 * $10) - (80 * $20) = $1000 - $1600 = 600 gain

2. Technical Study2. Technical Study

• Description of production methodologyDescription of production methodology• Identifying the required Identifying the required

equipment/technology/machineryequipment/technology/machinery• Identifying the location, space, engineering design, Identifying the location, space, engineering design,

technical drawings, etc.technical drawings, etc.• Description of the required energy, fuel, water, Description of the required energy, fuel, water,

transport, logistics and other infrastructure servicestransport, logistics and other infrastructure services• Estimating the required raw materials, capacity, Estimating the required raw materials, capacity,

machinery maintenance, labor, IT, the size of factory, machinery maintenance, labor, IT, the size of factory, etc.etc.

• Preparing the manufacturing design, drawings, Preparing the manufacturing design, drawings, leveling, basement, construction, infrastructure, leveling, basement, construction, infrastructure, finishing, electricity, water, health and safety finishing, electricity, water, health and safety measures, labor training, etc.measures, labor training, etc.

• Projection of fixed cost ad operating costProjection of fixed cost ad operating cost

Production ProcessProduction Process

• The production process section of the The production process section of the study is divided into the following study is divided into the following parts:parts:– Raw materialsRaw materials

•AvailabilityAvailability

•Future SupplyFuture Supply

– Facility DeterminationFacility Determination– Investment Capital NeedsInvestment Capital Needs– Labor needsLabor needs– Production costsProduction costs

Facility DeterminationFacility Determination• The minimum size facility to make The minimum size facility to make

the enterprise economically feasible the enterprise economically feasible must be determined.must be determined.

• Determining this size plant requires Determining this size plant requires the simultaneous analysis of both the simultaneous analysis of both demand (marketing) and supply demand (marketing) and supply (production including raw product).(production including raw product).

• The plant must be of sufficient size to The plant must be of sufficient size to maintain a low enough production maintain a low enough production cost per unit and but not large cost per unit and but not large enough to overload the market niche.enough to overload the market niche.

3. Financial Study3. Financial Study

• Estimate of capital expendituresEstimate of capital expenditures

• Estimate of operational expendituresEstimate of operational expenditures

• Estimate of revenues for the coming 5 yearsEstimate of revenues for the coming 5 years

• Estimate the sales over the life of the projectEstimate the sales over the life of the project

• Propose financing plan and equities structurePropose financing plan and equities structure

• Projection of the expected profits under Projection of the expected profits under various assumptionsvarious assumptions

• Financial analysis and ratiosFinancial analysis and ratios

Investment Capital NeedsInvestment Capital Needs

• What is the required capital investment What is the required capital investment necessary to construct the production necessary to construct the production facility?facility?

• What form of financing must be utilized What form of financing must be utilized to secure these funds?to secure these funds?

• What is the cost of these funds and What is the cost of these funds and what restrictions are attached to their what restrictions are attached to their use?use?

Operational CostsOperational Costs

• Includes items such as:Includes items such as:– Wage ratesWage rates– Management costsManagement costs– Raw material costsRaw material costs– Utility rate structuresUtility rate structures– Fixed Costs (Depreciation, Taxes, Interest, Fixed Costs (Depreciation, Taxes, Interest,

Insurance)Insurance)

• Costs should be broken down into a Costs should be broken down into a per unit basisper unit basis

ProfitabilityProfitability• Given the estimated revenues from the Given the estimated revenues from the

marketing section and the estimated marketing section and the estimated costs from the production section, the costs from the production section, the profitability of the enterprise can be profitability of the enterprise can be ascertained.ascertained.

• Profitability is defined as the excess of Profitability is defined as the excess of revenues over expenses.revenues over expenses.

• There are two distinct measures of There are two distinct measures of profitability.profitability.

Profitability MeasuresProfitability Measures

• Tax ProfitabilityTax Profitability– Revenues minus expensesRevenues minus expenses– This is the amount on which you pay This is the amount on which you pay

taxes.taxes.

• Economic ProfitabilityEconomic Profitability– Revenues minus expenses minus a Revenues minus expenses minus a

return to the owner.return to the owner.– This captures the value of the manage-This captures the value of the manage-

ment input of the owner.ment input of the owner.– Excess returns are considered Excess returns are considered

economic profit.economic profit.

Profitability ChartsProfitability Charts

• Break-even analysisBreak-even analysis– Shows the level of production where Shows the level of production where

revenues will just cover costs.revenues will just cover costs.– Prepare this on a tax profitability and an Prepare this on a tax profitability and an

economic profitability basis.economic profitability basis.

• Show the effect of risk on profitabilityShow the effect of risk on profitability– Prepare sensitivity analysis to determine Prepare sensitivity analysis to determine

effect of various revenue and cost effect of various revenue and cost streams on profitability.streams on profitability.

Working CapitalWorking Capital• Working capital is the cash used for day-Working capital is the cash used for day-

to-day expenses such as the payroll, to-day expenses such as the payroll, utility bills, etc.utility bills, etc.

• Adequate working capital is crucial to Adequate working capital is crucial to business survivalbusiness survival

• The cash flow statement demonstrates The cash flow statement demonstrates the need for working capital at specific the need for working capital at specific points in timepoints in time– Shows the uses of cashShows the uses of cash– Demonstrates the need for additional Demonstrates the need for additional

borrowingsborrowings

4. Management & Organizational 4. Management & Organizational StudyStudy

• Identify the required organizational structure Identify the required organizational structure for the project, department and unitsfor the project, department and units

• Description of the main roles and Description of the main roles and responsibilities for each department and responsibilities for each department and unitsunits

• Identifying main positions, jobs descriptions, Identifying main positions, jobs descriptions, roles and responsibilities,roles and responsibilities,

• Key competencies and skills among staffKey competencies and skills among staff• Preparing management structure and HRM Preparing management structure and HRM

manualmanual• Recommending of the legal entity of the Recommending of the legal entity of the

projectproject• Projecting the required HR and HR Projecting the required HR and HR

Development planDevelopment plan

LaborLabor• How many employees will be required to How many employees will be required to

run the production facility?run the production facility?• Compare facility needs to the local labor Compare facility needs to the local labor

force.force.– What special skills will be required? Are What special skills will be required? Are

these available from the current labor force?these available from the current labor force?– The local unemployment rate is not The local unemployment rate is not

necessarily an indicator of the labor force.necessarily an indicator of the labor force.

• Where will management and technicians Where will management and technicians come from? What costs are involved in come from? What costs are involved in getting them to work for you?getting them to work for you?

5. Socio-economic Study5. Socio-economic Study• The contribution to social benefitsThe contribution to social benefits• Adding value to local needsAdding value to local needs• Offering a product/serviceOffering a product/service• Social responsibility and community Social responsibility and community

outreach supportoutreach support• Contribution to local demands and Contribution to local demands and • Trade balanceTrade balance• Cost and benefits analysisCost and benefits analysis• Contribution to the added valueContribution to the added value• Contribution to generate more investment Contribution to generate more investment

and business opportunities and and business opportunities and employment opportunities.employment opportunities.

6. Environmental Impact 6. Environmental Impact assessment studyassessment study

• Assessing environmental impact of the Assessing environmental impact of the projectproject

• Assessing the project risk assessment on: Assessing the project risk assessment on: natural resources,natural resources,

• pollutions,pollutions,

• solid waste, solid waste,

• disposing industry waste and disposing industry waste and

• biodiversities impact.biodiversities impact.

• Other environmental risk and hazards, Other environmental risk and hazards,

• chemical treatment, emissions, poisons, etc. chemical treatment, emissions, poisons, etc.

Case studies reviewCase studies review

الحمة • دواجن اعالف تصنيع جدوى الحمة دراسة دواجن اعالف تصنيع جدوى دراسة

•Housing Construction Company

Bakeries صابرين•

Third Training DayThird Training Day

Evaluating Feasibility StudyEvaluating Feasibility Study

Product features Performance Mix & variety of products Service levels Small vs. large buyers Process technology Wage levels Product features Hiring, training,

motivation

Factors That Drive CostsFactors That Drive Costs

Economies of scale Asset utilization Capacity utilization

pattern• Seasonal, cyclical

Interrelationships Order processing and distribution Value chain linkages

• Marketing & sales• Logistics &

operations• Service

Factors That Drive Factors That Drive DifferentiationDifferentiation

• Unique product featuresUnique product features• Unique product performanceUnique product performance• Exceptional services Exceptional services • New technologiesNew technologies• Quality of inputsQuality of inputs• Exceptional skill or experienceExceptional skill or experience• Detailed informationDetailed information• Extensive personal relationships with Extensive personal relationships with

buyers and suppliersbuyers and suppliers

Evaluating Feasibility StudyEvaluating Feasibility Study

• Implementation check and Implementation check and • Fitness of time schedules, Fitness of time schedules, • Cost estimates, Cost estimates, • Viability and validity of the assumptions,Viability and validity of the assumptions,• Financial feasibility: Financial feasibility:

1.1. Capital expenditures,Capital expenditures,2.2. working capital, working capital, 3.3. cash flows, cash flows, 4.4. equities structures, equities structures, 5.5. debt ratios,debt ratios,6.6. financial analysis and profitability.financial analysis and profitability.

Financial AssessmentFinancial Assessment

• Payback periodPayback period

• Rate of returnRate of return

• Break even analysisBreak even analysis

• Rate of internal returnsRate of internal returns

• Net Present valueNet Present value

• Discounted cash flowsDiscounted cash flows

Payback periodPayback period• Payback period = total $ Payback period = total $

investment/annual incomeinvestment/annual income

Example: Example:

• One project spent $50,000 and One project spent $50,000 and earned annual income $10,000earned annual income $10,000

• Payback period =Payback period =

• Calculate: ???Calculate: ???

Rate of returnRate of returnAverage annual accounting income from projectAverage annual accounting income from project Average annual investment in the projectAverage annual investment in the project== Return on investment (ROI)Return on investment (ROI)

Average annual investment =Average annual investment = (Initial investment + (Initial investment + Salvage value at end) Salvage value at end) 22

Advantages of ROI method: Advantages of ROI method: • Simple to explain and compute using financial Simple to explain and compute using financial

statementsstatements• Rate of return = average profit after tax/average total Rate of return = average profit after tax/average total

investmentinvestment• Average profit after tax= Total annual profit/number of Average profit after tax= Total annual profit/number of

yearsyears• Average total investment = Total investment (value of Average total investment = Total investment (value of

starting assets) + (value of ending assets)/2starting assets) + (value of ending assets)/2

Breakeven AnalysisBreakeven Analysis

Breakeven pointBreakeven point Q QBEBE is the number of units that must be is the number of units that must be sold at price P such that total revenues (TR) equal total sold at price P such that total revenues (TR) equal total costs (TC).costs (TC).

TRTR = TC= TC

(P (P QQBEBE)) = = [FC + (VC [FC + (VC QQBEBE)])]

[(P - VC) [(P - VC) QQBEBE]] = = FCFC

QQBEBE = = [FC[FC(P - VC)] (P - VC)]

QQBEBE = = (FC(FCCM)CM)

At breakeven, the total contribution margin equals fixed costs.At breakeven, the total contribution margin equals fixed costs.

(CM (CM QQBEBE)) = = FCFC

Breakeven Analysis

-$250,000

-$200,000

-$150,000

-$100,000

-$50,000

$0

$50,000

$100,000

$150,000

$200,000

$250,000

0 100 200 300 400 500 600 700 800 900 1,000 1,100 1,200 1,300 1,400 1,500 1,600 1,700 1,800 1,900 2,000

Sales Volume

Ne

t In

co

me

Net Income at Sales Volume

Use break even analysis to determine sales volume Use break even analysis to determine sales volume needed to become profitableneeded to become profitable

Rate of internal returnsRate of internal returnsInternal rate of return (IRR) is the interest rate that Internal rate of return (IRR) is the interest rate that

equates the present value of future cash flows to equates the present value of future cash flows to the cash outflows.the cash outflows.

By definition: PV = FV By definition: PV = FV (1 + (1 + irrirr))Solution for a single cash flow: Solution for a single cash flow: irrirr = (FV = (FV PV) - 1PV) - 1

Comparison of IRR and DCF/NPV methodsComparison of IRR and DCF/NPV methods• Both consider time value of cash flowsBoth consider time value of cash flows• IRR indicates IRR indicates relativerelative return on investment return on investment• DCF/NPV indicates DCF/NPV indicates magnitude magnitude of investment’s of investment’s

returnreturn• IRR can yield multiple rates of returnIRR can yield multiple rates of return• IRR assumes all cash flows reinvested at project’s IRR assumes all cash flows reinvested at project’s

constant IRRconstant IRR• DCF/NPV discounts all cash flows with specified DCF/NPV discounts all cash flows with specified

discount ratediscount rate

Net Present valueNet Present value1.1. Identify after-tax cash flows for each periodIdentify after-tax cash flows for each period

2.2. Determine discount rateDetermine discount rate

3.3. Multiply by appropriate present-value factor Multiply by appropriate present-value factor (single or annuity) for each cash flow. PV (single or annuity) for each cash flow. PV factor is 1.0 for cash invested nowfactor is 1.0 for cash invested now

4.4. Sum of the present values of all cash flows Sum of the present values of all cash flows = net present value (NPV)= net present value (NPV)

5. If NPV 5. If NPV 0, then accept project0, then accept project

6. If NPV < 0, then reject project6. If NPV < 0, then reject project

NPVNPV is also known as discounted cash flow is also known as discounted cash flow ((DCFDCF).).

Value of a firm is equal to the present Value of a firm is equal to the present value of its expected cash flowsvalue of its expected cash flows

Invested Capital

MarketValue

PVCF2

PVCF3

PV

CFt

PVCF1

PVCF5

PVCF6

PVCF44

Discounted Cash Flow Method

n Expected Cash Flow

(1 + Cost of Capital)t

t = 1

Value of Firm =t

Example: Valuation of Coca Cola using Example: Valuation of Coca Cola using DCF methodDCF method

83,002

4,314

BookValue

11,800

4,419

4,628

4,734

4,504

4,819

4,957

5,078

5,177

5,249

Debt11,671

Firm Value

130,882

$ millions

Value to Equity = Firm Value - Debt

= $130,882 - $11,671

= $119,211

Market Value per Share = Value to equity / Shares outstanding

= $119,211 million / 2460 million shares

= $48 / share

Current Market Price = $44 / share

Market

Value

Added

107,411

Main components of an income Main components of an income statement statement

SalesSales

Cost of goods soldCost of goods sold

Gross profitGross profit

Operating expensesOperating expenses

Total operating Total operating expensesexpenses

Net income before Net income before taxestaxes

TaxesTaxes

Net incomeNet income

Main components of a Main components of a balance sheet balance sheet

AssetsAssets

LiabilitLiabilities and ies and OwnerOwners’ s’ EquityEquity

Cash flow is not a stand alone Cash flow is not a stand alone statementstatement

•Balance sheet and income statement Balance sheet and income statement are not are not consideringconsidering the timing of receipt and payment the timing of receipt and payment of cash in recognizing assets, liabilities, owners’ of cash in recognizing assets, liabilities, owners’ equity, income and expenses.equity, income and expenses.

•Cash flow statement tracks the timing of Cash flow statement tracks the timing of receipts and payments of cash to help the receipts and payments of cash to help the business analyze its cash flow situation.business analyze its cash flow situation.

•Cash flow statements is prepared on the basis Cash flow statements is prepared on the basis of financial information in the income of financial information in the income statement and balance sheet.statement and balance sheet.

Cash flow statement is divided to 3 Cash flow statement is divided to 3 sectionssections

• Operating activitiesOperating activities: principal operating activities of the : principal operating activities of the business. Main items considered are:business. Main items considered are:

– RevenuesRevenues– Accounts receivableAccounts receivable– ExpensesExpenses– Accounts payableAccounts payable– Prepaid expensesPrepaid expenses

• Investing activitiesInvesting activities: long term items. Main items considered : long term items. Main items considered are:are:

– Fixed assetsFixed assets– Long-term investmentsLong-term investments

• Financing activitiesFinancing activities: how the business is financed. Main items : how the business is financed. Main items considered are:considered are:

– CapitalCapital– DividendsDividends– LoansLoans– Interest Interest

How the cash flow statement is How the cash flow statement is prepared?prepared?

•There are 2 ways to prepare the operating section There are 2 ways to prepare the operating section of the cash flow statement:of the cash flow statement:

•Direct method: translates income statement items Direct method: translates income statement items – item by item – using information in the balance – item by item – using information in the balance sheet. For example; revenues in the income sheet. For example; revenues in the income statement are translated to “cash receipts from statement are translated to “cash receipts from customers” using the customers” using the changechange the accounts the accounts receivable from the comparative balance sheet.receivable from the comparative balance sheet.

•Indirect method: starts with net income in the Indirect method: starts with net income in the income statement and reconciles it to net cash income statement and reconciles it to net cash provided by operating activities through provided by operating activities through considering items in the balance sheet and considering items in the balance sheet and income statement. income statement.

Comparative Financial Analysis: Comparative Financial Analysis: Key RatiosKey Ratios

Profitability

Leverage

Activity

Liquidity

Type Examples Measures Indicators

Profit after taxesShareholder’s equity

Return on Equity (ROE)

Current Ratio

Asset Turnover

Inventory Turnover

Debt/Equity Ratio

Current AssetsCurrent Liabilities

Liabilities______Shareholders’ equity

Sales_________Total Assets

Sales_________Inventory

Productivity of firm’s value-adding activities

Measure of financial solvency

Asset useefficiency

Turnaround of inventory

Corporate financing; financial risk; default risk

Basic ways to improve ROA and ROEBasic ways to improve ROA and ROE Net Income

30,000

Profit Margin

Net Income / Revenues divided by

15.00%

Revenues

200,000

ROA

Net Income / Assets multiplied by

18.75%

Revenues

200,000

Asset Utilization

Revenues / Assets divided by

1.25

Assets

ROE 160,000

Net Income / Equity multiplied by

37.50%

Assets

160,000

Leverage Assets

Assets / Equity divided by

2.00 160,000

Equity

minus

80,000

Liabilities

80,000

Net Income

Profit Margin


Revenues

ROA


Revenues

Asset Utilization


Assets

ROE


Assets

Leverage Assets


Equity

minus

Liabilities

Exercise: ROE and ROAExercise: ROE and ROAA firm has the following financial data:

Assets =$ 200,000

Liabilities = 0

Equity = $ 200,000

Revenues = $200,000

Expenses = $180,000

Complete the ratio decomposition and determine

the ROA and ROE.

Exercise: ROE and ROAExercise: ROE and ROA Net Income

Profit Margin


Revenues

ROA


Revenues

Asset Utilization


Assets

ROE


Assets

Leverage Assets


Equity

minus

Liabilities

A firm has the following financial data:

Assets = $200,000

Liabilities = 0

Equity = $200,000

Revenues = $200,000

Expenses = $170,000

Complete the ratio decomposition and determine

the ROA and ROE.

Economic AssessmentEconomic Assessment• Cost and benefit analysisCost and benefit analysis•Can an estimate of required capital

investment be made?• Contribution to economic developmentContribution to economic development• Contribution to job creation and Contribution to job creation and

employmentemployment• Contribution to trade balance andContribution to trade balance and• export marketexport market• Contribution to added value andContribution to added value and• GDPGDP

Environmental Assessment

•What is the expected environmental effect of the option?

•How significant is the estimated reduction in wastes or emissions?

•Will the option affect public or operator health (positive or negative)? If so, what is the magnitude of these effects in terms of toxicity and exposure?

Information required when Information required when undertaking feasibility undertaking feasibility studystudy• Population statistics:Population statistics:

• Demographics statisticsDemographics statistics

• Socio-economic factorsSocio-economic factors

• EducationEducation

• Housing StatisticsHousing Statistics

Income LevelsIncome Levels

• Income per capitaIncome per capita

• Income distributionIncome distribution

• Income and consumption distributionIncome and consumption distribution

• Consumer preferencesConsumer preferences

• Consumption trendsConsumption trends

Law and legal data and policies Law and legal data and policies of public servicesof public services

• Restriction on importsRestriction on imports

• Customs tariffCustoms tariff

• Pricing policy Pricing policy

• Regulation and de-regulationRegulation and de-regulation

• Trade agreementTrade agreement

• Industry free tax zonesIndustry free tax zones

• IncubatorsIncubators

Data about the Data about the product/serviceproduct/service• Local productionLocal production

• Local demand and supplyLocal demand and supply

• Import/export productsImport/export products

• International trends in international International trends in international markets markets

Data on Product PricesData on Product Prices

• Prices of competitors productsPrices of competitors products

• Prices of similar productsPrices of similar products

• Prices of related productsPrices of related products

• Price wars and strategies adoptedPrice wars and strategies adopted

• Prices of wholesales and in retail Prices of wholesales and in retail pricesprices

• Trends on international market prices Trends on international market prices

Competitor analysis & Competitor analysis & market intelligence studies market intelligence studies

• Competitor analysis Competitor analysis

• Market intelligence studies Market intelligence studies

Research and Development Research and Development

• Researchers and Scientific CentersResearchers and Scientific Centers

• Others market researches and Others market researches and developmentdevelopment

• Hi-tech industry development centerHi-tech industry development center

• Technology laboratory Technology laboratory

• Innovation and product development Innovation and product development institutioninstitution

External Environmental External Environmental AnalysisAnalysis

Strategic IntentStrategic IntentStrategic MissionStrategic Mission

The ExternalThe ExternalEnvironmentEnvironment

Analysis of general environmentAnalysis of general environment

Analysis of industry environmentAnalysis of industry environment

Analysis of competitor environmentAnalysis of competitor environment

The ExternalThe ExternalEnvironmentEnvironment

General EnvironmentGeneral Environment

• Socio-cultural segmentSocio-cultural segment

Women in the workplaceWomen in the workplace Workforce diversityWorkforce diversity Attitudes about quality of worklifeAttitudes about quality of worklife Concerns about environmentConcerns about environment Shifts in work and career preferencesShifts in work and career preferences Shifts in product and service preferencesShifts in product and service preferences

• Economic segmentEconomic segment


Inflation ratesInflation rates Interest ratesInterest rates Trade deficits or surplusesTrade deficits or surpluses Budget deficits or surplusesBudget deficits or surpluses Personal savings ratePersonal savings rate Business savings ratesBusiness savings rates Gross domestic productGross domestic product


• Political/Legal SegmentPolitical/Legal Segment

Antitrust lawsAntitrust laws Taxation lawsTaxation laws Deregulation philosophiesDeregulation philosophies Labor training lawsLabor training laws Educational philosophies and policiesEducational philosophies and policies


• Technological SegmentTechnological Segment

Product innovationsProduct innovations Applications of knowledgeApplications of knowledge Focus of private and government-supported Focus of private and government-supported

R&D expendituresR&D expenditures New communication technologiesNew communication technologies


• Global SegmentGlobal Segment

Important political eventsImportant political events Critical global marketsCritical global markets Newly industrialize countriesNewly industrialize countries Different cultural and institutional attributesDifferent cultural and institutional attributes


• Demographic SegmentDemographic Segment

Population sizePopulation size Age structureAge structure Geographic distributionGeographic distribution Ethnic mixEthnic mix Income distributionIncome distribution

Industry EnvironmentIndustry Environment

• A set of factors that directly influences a A set of factors that directly influences a company and its competitive actions and company and its competitive actions and responsesresponses

• Interaction among these factors determine an Interaction among these factors determine an industry’s profit potentialindustry’s profit potential

Threat of new entrantsThreat of new entrants Power of suppliersPower of suppliers Power of buyersPower of buyers Product substitutesProduct substitutes Intensity of rivalryIntensity of rivalry

Five Forces Model of Five Forces Model of CompetitionCompetition

• Identify current and potential competitors Identify current and potential competitors and determine which firms serve themand determine which firms serve them

• Conduct competitive analysisConduct competitive analysis

• Recognize that suppliers and buyers can Recognize that suppliers and buyers can become competitorsbecome competitors

• Recognize that producers of potential Recognize that producers of potential substitutes may become competitorssubstitutes may become competitors

Threat of New Entrants

Threat of New Entrants

Bar

gain

ing

Pow

er o

f

Bar

gain

ing

Pow

er o

f Su

pplie

rsSu

pplie

rs

Bargaining Power of Bargaining Power of BuyersBuyers

Threat of Substitute

Threat of Substitute

Products

Products

Rivalry A

mong

Rivalry A

mong

Competing Firm

s

Competing Firm

s

Five Forces Model of Five Forces Model of CompetitionCompetition

Five Forces ofFive Forces ofCompetitionCompetition

Threat of New EntrantsThreat of New Entrants• Barriers to entryBarriers to entry

• Economies of scaleEconomies of scale

• Product differentiationProduct differentiation

• Capital requirementsCapital requirements

• Switching costsSwitching costs

• Access to distribution channelsAccess to distribution channels

• Cost disadvantages independent of scaleCost disadvantages independent of scale

• Government policyGovernment policy

• Expected retaliationExpected retaliation

Bargaining Power of Bargaining Power of SuppliersSuppliers

• A supplier group is powerful when:A supplier group is powerful when:

• it is dominated by a few large companiesit is dominated by a few large companies

• satisfactory substitute products are not available satisfactory substitute products are not available to industry firmsto industry firms

• industry firms are not a significant customer for industry firms are not a significant customer for the supplier groupthe supplier group

• suppliers’ goods are critical to buyers’ suppliers’ goods are critical to buyers’ marketplace successmarketplace success

• effectiveness of suppliers’ products has created effectiveness of suppliers’ products has created high switching costshigh switching costs

• suppliers are a credible threat to integrate suppliers are a credible threat to integrate forward into the buyers’ industryforward into the buyers’ industry

Bargaining Power of BuyersBargaining Power of Buyers

• Buyers (customers) are powerful when:Buyers (customers) are powerful when:

• they purchase a large portion of an industry’s they purchase a large portion of an industry’s total outputtotal output

• the sales of the product being purchased the sales of the product being purchased account for a significant portion of the seller’s account for a significant portion of the seller’s annual revenuesannual revenues

• they could easily switch to another productthey could easily switch to another product

• the industry’s products are undifferentiated or the industry’s products are undifferentiated or standardized, and buyers pose a credible threat standardized, and buyers pose a credible threat if they were to integrate backward into the if they were to integrate backward into the seller’s industryseller’s industry

Threat of Substitute Threat of Substitute ProductsProducts• Product substitutes are strong threat Product substitutes are strong threat

when:when:• customers face few switching costscustomers face few switching costs

• substitute product’s price is lowersubstitute product’s price is lower

• substitute product’s quality and performance substitute product’s quality and performance capabilities are equal to or greater than those capabilities are equal to or greater than those of the competing productof the competing product

Intensity of RivalryIntensity of Rivalry

• Intensity of rivalry is stronger when competitors:Intensity of rivalry is stronger when competitors:

• are numerous or equally balancedare numerous or equally balanced

• experience slow industry growthexperience slow industry growth

• have high fixed costs or high storage costshave high fixed costs or high storage costs

• lack differentiation or low switching costslack differentiation or low switching costs

• experience high strategic stakesexperience high strategic stakes

• have high exit barriershave high exit barriers

High Exit BarriersHigh Exit Barriers

• Common exit barriers include:Common exit barriers include:• specialized assets (assets with values linked to specialized assets (assets with values linked to

a particular business or location)a particular business or location)

• fixed costs of exit such as labor agreementsfixed costs of exit such as labor agreements

• strategic interrelationships (relationships of strategic interrelationships (relationships of mutual dependence between one business and mutual dependence between one business and other parts of a company’s operation, such as other parts of a company’s operation, such as shared facilities and access to financial markets)shared facilities and access to financial markets)

• emotional barriers (career concerns, loyalty to emotional barriers (career concerns, loyalty to employees, etc.)employees, etc.)

• government and social restrictionsgovernment and social restrictions

Case studyCase study• Complete feasibility study format Complete feasibility study format

and writing exercises: and writing exercises:

• Topics to be determined:Topics to be determined:1.1. AgribusinessAgribusiness

2.2. Retail IndustryRetail Industry

3.3. Service industryService industry

4.4. Manufacturing industryManufacturing industry

5.5. ICTICT

6.6. othersothers

Feasibility outline formatFeasibility outline format1.1. Executive SummaryExecutive Summary2.2. Regional Socio-Economic Situation (General Regional Socio-Economic Situation (General

Description of the current situation). Most likely Description of the current situation). Most likely including brief on your local economy.including brief on your local economy.

3.3. Legal StudyLegal Study4.4. Financial PlanFinancial Plan5.5. Project Implementation ScheduleProject Implementation Schedule6.6. Market Study and Marketing Market Study and Marketing 7.7. Detail Description of Activities Detail Description of Activities 8.8. Environmental protectionEnvironmental protection9.9. ControlControl10.10.Financial Analysis and Projections Financial Analysis and Projections 11.11.11) Social Economic Effects / Multiplier effects, 11) Social Economic Effects / Multiplier effects,

related studies related studies 12.12.12) Options Analysis on different hypothesis and 12) Options Analysis on different hypothesis and

scenariosscenarios

Writing pitfall for feasibility Writing pitfall for feasibility studystudy

Summary guide when writing key Summary guide when writing key componentscomponents

Feasibility Study ContentsFeasibility Study Contents• Venture ConceptVenture Concept

• Market AssessmentMarket Assessment

• Technical Feasibility of your ideaTechnical Feasibility of your idea

• Your Marketing PlanYour Marketing Plan

• Managing the Supply SituationManaging the Supply Situation

• Conduct cost and profitability Conduct cost and profitability assessmentassessment

• Plan for future actionPlan for future action

Feasibility Study ContentsFeasibility Study Contents• Venture ConceptVenture Concept

– Explain clearly and concisely the principal Explain clearly and concisely the principal concept underlying your venture and what concept underlying your venture and what sets it apart from other businessessets it apart from other businesses

• Market AssessmentMarket Assessment– Describe the profile of your principal target Describe the profile of your principal target

customerscustomers– Indicate current market size, trends and Indicate current market size, trends and

seasonal patternsseasonal patterns– How do you plan to test your idea?How do you plan to test your idea?– Describe any market research or customer Describe any market research or customer

surveys you plan to conductsurveys you plan to conduct– Assess the nature of your competitionAssess the nature of your competition– Estimate your expected sales and market Estimate your expected sales and market

shareshare

Feasibility Study Contents Feasibility Study Contents ……• Technical FeasibilityTechnical Feasibility

– Indicate the degree of innovativeness of your Indicate the degree of innovativeness of your venture idea and the risks associated with itventure idea and the risks associated with it

– Does it need to be subjected to some form of Does it need to be subjected to some form of technical evaluation or assessment?technical evaluation or assessment? Does the business need accreditation?Does the business need accreditation? Do you have a prototype? Has it been Do you have a prototype? Has it been

tested from a technological point of view? tested from a technological point of view? Will it have the specifications to meet the Will it have the specifications to meet the needs and expectations of the market?needs and expectations of the market?

Can it be mass produced? Job shop Can it be mass produced? Job shop production? Sub contracted?production? Sub contracted?

Feasibility Study Contents Feasibility Study Contents ……• Your Marketing PlanYour Marketing Plan

– Detail the marketing strategy you plan to Detail the marketing strategy you plan to useuse

– Describe your marketing plan including Describe your marketing plan including your sales strategy, advertising and your sales strategy, advertising and promotion plans, pricing policy and promotion plans, pricing policy and channels of distribution.channels of distribution.

Feasibility Study Contents Feasibility Study Contents ……

• Managing the Supply SituationManaging the Supply Situation

– How do you plan to assure continuing How do you plan to assure continuing access to critical supplies of raw materials access to critical supplies of raw materials and component parts at reasonable prices?and component parts at reasonable prices?

– Will you produce or subcontract your Will you produce or subcontract your production?production?


• Cost and Profitability AssessmentCost and Profitability Assessment

– Estimate funds required to set up your Estimate funds required to set up your businessbusiness

– Develop short-term financial projections Develop short-term financial projections including:including: Cash flow forecastsCash flow forecasts Pro forma profit and loss statementsPro forma profit and loss statements Pro forma balance sheetPro forma balance sheet Break even analysisBreak even analysis


• Plan for future actionPlan for future action

– What were the strong and weak points of What were the strong and weak points of your venture idea?your venture idea?

– Did your assessment indicate the business Did your assessment indicate the business was likely to be profitable?was likely to be profitable?

– Is it sufficiently attractive to proceed with Is it sufficiently attractive to proceed with the development of a complete business the development of a complete business plan?plan?

Any comments?Any comments?

Thanks for participationThanks for participation

If you need any help, feel free to send your If you need any help, feel free to send your queries/questions through:queries/questions through:

Consulting Group for Development, CGDConsulting Group for Development, CGDBy: Khaled AyeshBy: Khaled Ayesh

Chief Technical Advisor and Team LeaderChief Technical Advisor and Team Leader

Email: Email: [email protected]@hotmail.comJawwal: +972-599-689118Jawwal: +972-599-689118

mailto:[email protected]