Month: December 2021

Project finance is the long-term financing of infrastructure and industrial projects based upon the projected cash flows of the project rather than the balance sheets of its sponsors. Usually, a project financing structure involves a number of equity investors, known as ‘sponsors‘, and a ‘syndicate‘ of banks or other lending institutions that provide loans to the operation. They are most commonly non-recourse loans, which are secured by the project assets and paid entirely from project cash flow, rather than from the general assets or creditworthiness of the project sponsors, a decision in part supported by financial modelling; see Project finance model. The financing is typically secured by all of the project assets, including the revenue-producing contracts. Project lenders are given a lien on all of these assets and are able to assume control of a project if the project company has difficulties complying with the loan terms.

Generally, a special purpose entity is created for each project, thereby shielding other assets owned by a project sponsor from the detrimental effects of a project failure. As a special purpose entity, the project company has no assets other than the project. Capital contribution commitments by the owners of the project company are sometimes necessary to ensure that the project is financially sound or to assure the lenders of the sponsors’ commitment. Project finance is often more complicated than alternative financing methods. Traditionally, project financing has been most commonly used in the extractive (mining), transportation, telecommunications, and power industries, as well as for sports and entertainment venues.

Risk identification and allocation is a key component of project finance. A project may be subject to a number of technical, environmental, economic and political risks, particularly in developing countries and emerging markets. Financial institutions and project sponsors may conclude that the risks inherent in project development and operation are unacceptable (unfinanceable). “Several long-term contracts such as construction, supply, off-take and concession agreements, along with a variety of joint-ownership structures are used to align incentives and deter opportunistic behaviour by any party involved in the project.” The patterns of implementation are sometimes referred to as “project delivery methods.” The financing of these projects must be distributed among multiple parties, so as to distribute the risk associated with the project while simultaneously ensuring profits for each party involved. In designing such risk-allocation mechanisms, it is more difficult to address the risks of developing countries’ infrastructure markets as their markets involve higher risks.

A project can only come together with all the necessary materials and labor, and those materials and labours cost money. Putting together a budget that keeps costs to a minimum, while maximizing the project’s quality and scope can be challenging. This is why proper cost estimation is important.

Cost estimation in project management is the process of forecasting the financial and other resources needed to complete a project within a defined scope. Cost estimation accounts for each element required for the project from materials to labour and calculates a total amount that determines a project’s budget. An initial cost estimate can determine whether an organization greenlights a project, and if the project moves forward, the estimate can be a factor in defining the project’s scope. If the cost estimation comes in too high, an organization may decide to pare down the project to fit what they can afford (it is also required to begin securing funding for the project). Once the project is in motion, the cost estimate is used to manage all of its affiliated costs in order to keep the project on budget.

Project Cost Estimation is a crucial process that involves approximating the overall expenditure of a project. The accuracy and effectiveness of cost estimation and budgeting in project management depend on the precision and comprehensiveness of the project scope, known as the scope baseline. This scope defines the project’s boundaries, constraints such as timelines, available resources, and budget limitations.

To determine the project’s costs, the risk register plays a pivotal role. It aids in calculating various cost estimates, including expenses associated with contingency plans and those incurred to mitigate risks. By analyzing potential risks and their financial impact, project managers can better plan for unforeseen events and allocate resources more effectively.

There are two key types of costs addressed by the cost estimation process:

• Direct costs: Costs associated with a single area, such as a department or the project itself. Examples of direct costs include fixed labor, materials, and equipment.
• Indirect costs: Costs incurred by the organization at large, such as utilities and quality control.

Various cost types into categories:

• Labour cost: The cost of team members working on the project, both in terms of wages and time.
• Equipment cost: The cost of resources required for the project, from physical tools to software to legal permits.
• Cost of supplies:
• Travel cost
• Training cost
• Overhead cost, etc.

Types of Financing, Sources of Finance

1. Non Recourse Loan: A loan in which the lender cannot claim more than the collateral as repayment in the event that the loan is enforced.
2. Full Recourse Loan: A loan in which the lender can claim more than the collateral as repayment in the event that the loan is enforced. Thus, a full recourse loan places the Sponsor’s assets at risk.
3. Limited Recourse Loan: A loan in which the lender can claim more than the collateral, subject to some restrictions, as repayment in the event that the loan is enforced.

Project Financing Participants and Agreements

Additional Equity Investors: In addition to the sponsors, there frequently are additional equity investors in the project company. These additional investors may include one or more of the other project participants.

Sponsor/Developer: The sponsors or developers of a project financing is the party that organizes all of the other parties and typically controls, and makes an equity investment in, the company or other entity that owns the project. If there is more than one sponsor, the sponsors typically will form a corporation or enter into a partnership or other arrangement pursuant to which the sponsors will form a “Project company” to own the project and establish their respective rights and responsibilities regarding the project.

Construction Contractor: The construction contractor enters into a contract with the project company for the design, engineering, and construction of the project.

Operator: The project operator enters into a long-term agreement with the project company for the day-to-day operation and maintenance of the project.

Feedstock Supplier: The feedstock suppliers enter into a long-term agreement with the project company for the supply of feedstock (i.e., energy, raw materials or other resources) to the project (e.g., for a power plant, the feedstock supplier will supply fuel; for a paper mill, the feedstock supplier will supply wood pulp).

Product Off taker: The product off takers enters into a long-term agreement with the project company for the purchase of all of the energy, goods or other product produced at the project.

Lender: The lender in a project financing is a financial institution or group of financial institutions that provide a loan to the project company to develop and construct the project and that take a security interest in all of the project assets.

Techniques used to estimate project cost

To estimate project costs, various techniques can be employed, some of which include:

1. Analogous Estimating: This technique relies on expert judgment and information from similar previous projects. The cost of a current project is estimated based on the cost of similar past projects, with adjustments made for any differences.
2. Parametric Estimating: Past data and historical records are used to estimate costs for the current project. Mathematical models and algorithms are applied to calculate costs based on relevant parameters.
3. Bottom-Up Estimating: This technique is considered the most reliable when the project scope is well-defined. Cost estimates are derived by breaking down the project into work packages or deliverables, and then estimating the cost for each resource or component.
4. Three-Point Estimation: This method involves using three estimates – optimistic, pessimistic, and most likely – to calculate the expected cost, taking into account the uncertainties associated with the project.
5. Reserve Analysis: Reserve analysis involves setting aside contingency reserves to account for potential cost overruns or risks that may impact the project’s budget.
6. Cost of Quality: This technique considers the cost of ensuring quality throughout the project lifecycle. It involves investing in prevention, appraisal, and failure costs to maintain high-quality deliverables.
7. PERT Estimating: Program Evaluation and Review Technique (PERT) utilizes a probabilistic approach to estimate project costs, incorporating uncertainty and risk factors in the estimation process.
8. Vendor Bid Analysis: When external vendors are involved in the project, analyzing their bids and proposals can provide valuable insights into the estimated costs of specific project components.

Each of these techniques has its strengths and weaknesses, and the choice of method depends on factors like project complexity, data availability, and the level of accuracy required for cost estimation. By employing a combination of these techniques, project managers can arrive at more reliable cost estimates and better manage project budgets.

Impact of Risk Handling Measures

Risk management is the identification, evaluation, and prioritization of risks (defined in ISO 31000 as the effect of uncertainty on objectives) followed by coordinated and economical application of resources to minimize, monitor, and control the probability or impact of unfortunate events or to maximize the realization of opportunities.

Risks can come from various sources including uncertainty in international markets, threats from project failures (at any phase in design, development, production, or sustaining of life-cycles), legal liabilities, credit risk, accidents, natural causes and disasters, deliberate attack from an adversary, or events of uncertain or unpredictable root-cause. There are two types of events i.e. negative events can be classified as risks while positive events are classified as opportunities. Risk management standards have been developed by various institutions, including the Project Management Institute, the National Institute of Standards and Technology, actuarial societies, and ISO standards. Methods, definitions and goals vary widely according to whether the risk management method is in the context of project management, security, engineering, industrial processes, financial portfolios, actuarial assessments, or public health and safety.

Strategies to manage threats (uncertainties with negative consequences) typically include avoiding the threat, reducing the negative effect or probability of the threat, transferring all or part of the threat to another party, and even retaining some or all of the potential or actual consequences of a particular threat. The opposite of these strategies can be used to respond to opportunities (uncertain future states with benefits).

Certain risk management standards have been criticized for having no measurable improvement on risk, whereas the confidence in estimates and decisions seems to increase.

A successful risk management program helps an organization consider the full range of risks it faces. Risk management also examines the relationship between risks and the cascading impact they could have on an organization’s strategic goals.

This holistic approach to managing risk is sometimes described as enterprise risk management because of its emphasis on anticipating and understanding risk across an organization. In addition to a focus on internal and external threats, enterprise risk management (ERM) emphasizes the importance of managing positive risk. Positive risks are opportunities that could increase business value or, conversely, damage an organization if not taken. Indeed, the aim of any risk management program is not to eliminate all risk but to preserve and add to enterprise value by making smart risk decisions.

“We don’t manage risks so we can have no risk. We manage risks so we know which risks are worth taking, which ones will get us to our goal, which ones have enough of a payout to even take them,” said Forrester Research senior analyst Alla Valente, a specialist in governance, risk and compliance.

Thus, a risk management program should be intertwined with organizational strategy. To link them, risk management leaders must first define the organization’s risk appetite i.e., the amount of risk it is willing to accept to realize its objectives.

The formidable task is to then determine “Which risks fit within the organization’s risk appetite and which require additional controls and actions before they are acceptable,” explained Notre Dame University Senior Director of IT Mike Chapple in his article on risk appetite vs. risk tolerance. Some risks will be accepted with no further action necessary. Others will be mitigated, shared with or transferred to another party, or avoided altogether.

Every organization faces the risk of unexpected, harmful events that can cost it money or cause it to close. Risks untaken can also spell trouble, as the companies disrupted by born-digital powerhouses, such as Amazon and Netflix, will attest. This guide to risk management provides a comprehensive overview of the key concepts, requirements, tools, trends and debates driving this dynamic field. Throughout, hyperlinks connect to other TechTarget articles that deliver in-depth information on the topics covered here, so readers should be sure to click on them to learn more.

Risk response plan

Risk response planning combines our efforts thus far into a viable risk response for each threat and opportunity we’ve identified as falling within the range of our risk tolerance threshold. Risk response planning increases the probability and/or impact of opportunities identified within the predetermined tolerance range of our risk register, and reduces the probability and/or impact of any threats.

There are four mitigation strategies to consider when developing a Risk Response Plan for both threats and opportunities.

Response to threats:

• Avoid: change plans
• Mitigate: reduce the probability and/or impact of the threat on the project
• Transfer: assign the risk to someone else
• Accept: do nothing

Response to opportunities:

• Exploit: make the opportunity more likely
• Enhance: increase the value of the opportunity to the project
• Share: partner with someone who can capture the opportunity
• Accept: do nothing

Risk monitoring

The last step is risk monitoring. The project manager monitors the risk register, executing on response plans, as well as documenting subsequent threats and opportunities as they become known throughout the project life cycle.

Risk planning is like any other project planning process, and is never really done until the project itself is complete; therefore, a project manager’s risk monitoring is finished only when the project is complete.

Work break Down Structure

A work-breakdown structure (WBS) in project management and systems engineering is a deliverable-oriented breakdown of a project into smaller components. A work breakdown structure is a key project deliverable that organizes the team’s work into manageable sections. The Project Management Body of Knowledge (PMBOK 5) defines the work-breakdown structure as a “hierarchical decomposition of the total scope of work to be carried out by the project team to accomplish the project objectives and create the required deliverables.”

A work-breakdown structure element may be a product, data, service, or any combination of these. A WBS also provides the necessary framework for detailed cost estimation and control while providing guidance for schedule development and control.

Breaking work into smaller tasks is a common productivity technique used to make the work more manageable and approachable. For projects, the Work Breakdown Structure (WBS) is the tool that utilizes this technique and is one of the most important project management documents. It singlehandedly integrates scope, cost and schedule baselines ensuring that project plans are in alignment.

The Project Management Institute (PMI) Project Management Book of Knowledge (PMBOK) defines the Work Breakdown Structure as a “deliverable oriented hierarchical decomposition of the work to be executed by the project team.” There are two types of WBS:

1) Deliverable-Based

2) Phase-Based.

The most common and preferred approach is the Deliverable-Based approach. The main difference between the two approaches are the Elements identified in the first Level of the WBS.

How to Make a Work Breakdown Structure

A good Work Breakdown Structure is created using an iterative process by following these steps and meeting these guidelines:

Gather critical project documents.

Identify content containing project deliverables, such as the Project Charter, Scope Statement and Project Management Plan (PMP) subsidiary plans.

• Identify Key Team Members
• Identify the appropriate project team members.
• Analyze the documents and identify the deliverables.

Define Level 1 Elements

Define the Level 1 Elements. Level 1 Elements are summary deliverable descriptions that must capture 100% of the project scope.

Verify 100% of scope is captured. This requirement is commonly referred to as the 100% Rule.

Decompose (Breakdown) Elements

Begin the process of breaking the Level 1 deliverables into unique lower-Level deliverables. This “breaking down” technique is called Decomposition.

Continue breaking down the work until the work covered in each Element is managed by a single individual or organization. Ensure that all Elements are mutually exclusive.

Ask the question, would any additional decomposition make the project more manageable? If the answer is “no”, the WBS is done.

Create Wbs Dictionary

Define the content of the WBS Dictionary. The WBS Dictionary is a narrative description of the work covered in each Element in the WBS. The lowest Level Elements in the WBS are called Work Packages.

Create the WBS Dictionary descriptions at the Work Package Level with detail enough to ensure that 100% of the project scope is covered. The descriptions should include information such as, boundaries, milestones, risks, owner, costs, etc.

Create Gantt Chart Schedule

Decompose the Work Packages to activities as appropriate.

Export or enter the Work Breakdown Structure into a Gantt chart for further scheduling and project tracking.

Several startup valuation methods are available for use by financial analysts. Startups, in the most general sense, are new business ventures started up by an entrepreneur. They usually tend to focus on developing unique ideas or technologies and introducing them into the market in the form of a new product or service.

Business valuation is never straightforward for any company. For startups with little or no revenue or profits and less-than-certain futures, the job of assigning a valuation is particularly tricky. For mature, publicly listed businesses with steady revenues and earnings, normally it’s a matter of valuing them as a multiple of their earnings before interest, taxes, depreciation, and amortization (EBITDA) or based on other industry-specific multiples. But it’s a lot harder to value a new venture that’s not publicly listed and may be years away from sales.

Asset Based

This approach focuses on the fair market value (FMV), or the net asset value (NAV) of the company. calculated the total assets less the total liabilities to figure out the cost of re-creating the company. There is little room left to decide which of the assets or liabilities of the company has to be included in the company valuation and how exactly we measure the worth of each.

Other than this, there are two other methods of valuation that are used. The market approach, which looks at what similar businesses in the market are worth, and the earnings approach, which estimates the total amount of money that they business might produce in the future.

The actual value in the asset-based approach to calculate the company valuation could be much higher than the sum of all the recorded assets of the business. Let us take for instance the balance sheet of the company. The balance sheet may not always have all the significant assets like the company’s methods of conducting business and internally developed products.

This happens as only the records which the owner has paid for appear on the company’s balance sheet. So, if there are other assets of the business, they are not recorded in the balance sheet. Other than this, some companies may have special products or services that make them unique. Putting a price on these for selling the business can be difficult.

Adjusted Net Asset Method

The adjusted net asset method can be used when a company has been generating losses, is not operating or the company only holds investments or real estate. This is one of the methods of valuation that is utilized for getting the estimated value of the business.

To get the fair market value, we would have to get the difference between the fair market value of the total assets and the total liabilities of the company. Let us understand how it is done.

Finding the Fair Market Value of Assets

The asset-based method of valuation starts by preparing a financial image of the business from the information that we have on the balance sheet. The current asset value would be different compared to the acquisition costs. Even though the balance sheet has all the assets and liabilities listed on it at historical cost, correctly utilizing this approach is based entirely on recasting those costs and obtaining the current value.

Earnings Based

This is another common method of valuation and is based on the idea that the actual value of a business lies in the ability to produce revenue in the future. There are a lot of methods of valuation under the earning value approach, but the most common one is capitalizing past earnings.

Capitalization of earnings is determined by calculating the NPV (Net present value) of the expected future cash flows or profits. The estimate here is found by taking the future earnings of the company and dividing them by a cap rate (capitalization rate).

In short, this is an income-valuation approach that lets us know the value of a company by analyzing the annual rate of return, the current cash flow and the expected value of the business.

This approach of the capitalization of earnings, being one of the conventional methods of valuation, helps investors figure out the possible risks and return of acquiring a company.

As soon as all the variables are known, the calculation of the capitalization rate is obtained with a simple formula. The formula is operating income divided by the purchase price. At first, the thing to be determined is the annual gross income of the investment.

After this, the operating expenses has to be subtracted to find out the total operating income. Then this value is divided by the investment’s/property’s purchase cost to find out the capitalization rate.

Disadvantages of Capitalization of Earnings Method

There isn’t one perfect method to determine a company’s value, which is why assessing a company’s future earnings has some drawbacks. At first, the method used to predict the future earnings might give an inaccurate figure, which would eventually result in less than expected generated profits.

In addition to this, exceptional circumstances can occur that eventually compromises the earnings, and affect the valuation of the investment. Further, a business that has just entered the market might lack adequate information for finding out an accurate valuation of the company.

The buyer has to know all about the desired ROI and the acceptable risks, as the capitalization rate has to be reflected in the risk tolerance, market characteristics of the buyer, and the expected growth factor of the business. For instance, if a buyer is not aware of the targeted rate, he might pass on a more suitable investment or overpay for an investment.

Discounted Cash flow Models

For most startups especially those that have yet to start generating earnings the bulk of the value rests on future potential. Discounted cash flow analysis then represents an important valuation approach. DCF involves forecasting how much cash flow the company will produce in the future and then, using an expected rate of investment return, calculating how much that cash flow is worth. A higher discount rate is typically applied to startups, as there is a high risk that the company will inevitably fail to generate sustainable cash flows.

The trouble with DCF is the quality of the DCF depends on the analyst’s ability to forecast future market conditions and make good assumptions about long-term growth rates. In many cases, projecting sales and earnings beyond a few years becomes a guessing game. Moreover, the value that DCF models generate is highly sensitive to the expected rate of return used for discounting cash flows. So, DCF needs to be used with much care.

Risk management is the practice of identifying, evaluating, and preventing or mitigating risks to a project that have the potential to impact the desired outcomes. Project managers are typically responsible for overseeing the risk management process throughout the duration of a given project.

Project risk management is the process of identifying, analyzing and responding to any risk that arises over the life cycle of a project to help the project remain on track and meet its goal. Risk management isn’t reactive only; it should be part of the planning process to figure out risk that might happen in the project and how to control that risk if it in fact occurs.

A risk is anything that could potentially impact your project’s timeline, performance or budget. Risks are potentialities, and in a project management context, if they become realities, they then become classified as “issues” that must be addressed. So risk management, then, is the process of identifying, categorizing, prioritizing and planning for risks before they become issues.

Risk management can mean different things on different types of projects. On large-scale projects, risk management strategies might include extensive detailed planning for each risk to ensure mitigation strategies are in place if issues arise. For smaller projects, risk management might mean a simple, prioritized list of high, medium and low priority risks.

To effectively manage risk, project managers must have a clear understanding of their objectives so they can identify any possible barriers that could impact the team’s ability to produce results.

Types of Project Risk

Beyond the basics of what “risk” means, project managers should also know the different types of risks they may encounter. Depending on the project type, the factors that should be considered will differ.

There are several types of risks that occur frequently, regardless of the specifics of the project. These common types of risk include:

• Cost: The risk of events that impact the budget, especially those that cause the project to be completed over budget. Errors in cost estimation commonly generate risk in addition to external factors.
• Schedule: The risk of unplanned scheduling conflicts, such as events that cause the project to be delayed. Scope creep is a common reason for scheduling issues and project delays.
• Performance: The risk of events that cause the project to produce results that are inconsistent with the project specifications.

Risk Management Process

Risk owners require several skills to manage project risk well, which include:

• Communication: Having the ability to communicate well with stakeholders, so that everyone understands the role they play in reducing the impact of risk.
• Strategic thinking: Being strategic and having the ability to problem solve and come up with solutions for the project risks identified.
• An understanding of the organisation: Knowing the businesses’ strategic direction, goals and risk appetite.
• Planning: Ensuring that the risk management plan is being actioned throughout the project lifecycle.
• Resourcefulness: Being quick to act under pressure to ensure that the project risks are addressed as soon as possible.

Risk Analysis & Identification

Identify and assess the potential risks

When it comes to identifying and assessing the potential risks related to the project, consider how a risk could occur, what the impact would be and what you can do to reduce the probability and impact (if you can) of the project risk. Understanding how much control you have over the risk is key. For some risks, you may have very little control over them. Keep in mind that along with identifying risk events, as mentioned above you should also list any project risks that can be identified as opportunities or uncertainty related to the project. Risk events and opportunities are often easier to identify as they have clear impacts, whereas uncertainty can be harder to measure as the result of a risk is unknown and is difficult to measure.

Assign a risk owner

Whether it is a dedicated risk manager, or a member of the project team, every project will need a risk owner assigned to keep track of risks throughout the project lifecycle. The risk owner is the key person who manages the risk management strategy. This doesn’t mean that the risk owner must address every risk that could impact the project, however, instead they have the responsibility of assigning ownership to team members and stakeholders, as well as updating and keeping track of the risk management plan. If you’re the risk owner, it’s key to make sure that every member of the team is aware of their role in reducing and mitigating project risk.

Draw on subject matter experts

As part of your risk management strategy in project management it is essential to touch base with subject matter experts, such as contractors and senior stakeholders. Receiving input from others will help ensure you have crossed off all the potential project risks, as you may find that others have insights into risks you may not have discovered on your own. They can also provide advice on effective strategies they have implemented in previous projects, that you could integrate into your risk management plan. Also see if your organisation has risk registers from past projects completed available to review and any lessons learned reports.

Determine the probability of a project risk occurring

Once you have a list of the possible risks, the next step in your project risk assessment is ranking the risks by assigning probability. That way you will know which risks are more likely to occur and which would have the largest impact on your project. The risks that you measure that will have the highest impact, should be addressed first. There are many different formulas for measuring risk, however one of the popular ways is assigning a number to the risk.

Consider the action you will take

Once you have all the project risks ranked according to the probability of the risk occurring, the next step will be planning out the actions you will take. With some risks you may be able to eliminate them entirely, however others may need to follow a mitigation strategy.

Include risk Management in your post project review

Just as one project comes to an end, you may find yourself handed your next project, leaving little time for a post project review. However, the greatest learnings can come from analyzing how your project went, including the risk management. So, when the project comes to an end, take the time to evaluate what went well on the project, what could have been handled better and the learnings you can you take with you to your next project.

Managing Risk throughout the Organization

Building a risk management protocol into your organization’s culture by creating a consistent set of standard tools and templates, with training, can reduce overhead over time. That way, each time you start a new project, it won’t be like having to reinvent the wheel.

Things such as your organization’s records and history are an archive of knowledge that can help you learn from that experience when approaching risk in a new project. Also, by adopting the attitudes and values of your organization to become more aware of risk, your organization can develop a better sense of the nature of uncertainty as a core business issue. With improved governance comes better planning, strategy, policy and decisions.

A cost-benefit analysis is a systematic process that businesses use to analyze which decisions to make and which to forgo. The cost-benefit analyst sums the potential rewards expected from a situation or action and then subtracts the total costs associated with taking that action. Some consultants or analysts also build models to assign a dollar value on intangible items, such as the benefits and costs associated with living in a certain town.

Before building a new plant or taking on a new project, prudent managers conduct a cost-benefit analysis to evaluate all the potential costs and revenues that a company might generate from the project. The outcome of the analysis will determine whether the project is financially feasible or if the company should pursue another project.

In many models, a cost-benefit analysis will also factor the opportunity cost into the decision-making process. Opportunity costs are alternative benefits that could have been realized when choosing one alternative over another. In other words, the opportunity cost is the forgone or missed opportunity as a result of a choice or decision. Factoring in opportunity costs allows project managers to weigh the benefits from alternative courses of action and not merely the current path or choice being considered in the cost-benefit analysis.

By considering all options and the potential missed opportunities, the cost-benefit analysis is more thorough and allows for better decision-making.

The Cost-Benefit Analysis Process

A cost-benefit analysis should begin with compiling a comprehensive list of all the costs and benefits associated with the project or decision.

The costs involved in a CBA might include the following:

• Direct costs would be direct labor involved in manufacturing, inventory, raw materials, manufacturing expenses.
• Indirect costs might include electricity, overhead costs from management, rent, utilities.
• Intangible costs of a decision, such as the impact on customers, employees, or delivery times.
• Opportunity costs such as alternative investments, or buying a plant versus building one.
• Cost of potential risks such as regulatory risks, competition, and environmental impacts.

Advantages:

• Higher revenue and sales from increased production or new product.
• Intangible benefits, such as improved employee safety and morale, as well as customer satisfaction due to enhanced product offerings or faster delivery.
• Competitive advantage or market share gained as a result of the decision.

An analyst or project manager should apply a monetary measurement to all of the items on the cost-benefit list, taking special care not to underestimate costs or overestimate benefits. A conservative approach with a conscious effort to avoid any subjective tendencies when calculating estimates is best suited when assigning a value to both costs and benefits for a cost-benefit analysis.

Finally, the results of the aggregate costs and benefits should be compared quantitatively to determine if the benefits outweigh the costs. If so, then the rational decision is to go forward with the project. If not, the business should review the project to see if it can make adjustments to either increase benefits or decrease costs to make the project viable. Otherwise, the company should likely avoid the project.

The Purpose of Cost-Benefit Analysis

The purpose of cost-benefit analysis in project management is to have a systemic approach to figure out the pluses and minuses of various paths through a project, including transactions, tasks, business requirements and investments. The cost-benefit analysis gives you options, and it offers the best approach to achieve your goal while saving on investment.

There are two main purposes in using CBA:

• To determine if the project business case is sound, justifiable and feasible by figuring out if its benefits outweigh costs.
• To offer a baseline for comparing projects by determining which project’s benefits are greater than its costs.

Limitations of the Cost-Benefit Analysis

For projects that involve small- to mid-level capital expenditures and are short to intermediate in terms of time to completion, an in-depth cost-benefit analysis may be sufficient enough to make a well-informed, rational decision. For very large projects with a long-term time horizon, a cost-benefit analysis might fail to account for important financial concerns such as inflation, interest rates, varying cash flows, and the present value of money.

Alternative capital budgeting analysis methods, including net present value (NPV), could be more appropriate for these situations. The concept of present value states that an amount of money or cash in the present day is worth more than receiving the amount in the future since today’s money could be invested and earn income.

One of the benefits of using the net present value for deciding on a project is that it uses an alternative rate of return that could be earned if the project had never been done. That return is discounted from the results. In other words, the project needs to earn at least more than the rate of return that could be earned elsewhere or the discount rate.

However, with any type of model used in performing a cost-benefit analysis, there are a significant number of forecasts built into the models. The forecasts used in any CBA might include future revenue or sales, alternative rates of return, expected costs, and expected future cash flows. If one or two of the forecasts are off, the CBA results would likely be thrown into question, thus highlighting the limitations in performing a cost-benefit analysis.

Efficient Investment Analysis

Investment analysis is a broad term for many different methods of evaluating investments, industry sectors, and economic trends. It can include charting past returns to predict future performance, selecting the type of investment that best suits an investor’s needs, or evaluating individual securities such as stocks and bonds to determine their risks, yield potential, or price movements. Investment analysis is key to a sound portfolio management strategy.

The aim of investment analysis is to determine how an investment is likely to perform and how suitable it is for a particular investor. Key factors in investment analysis include the appropriate entry price, the expected time horizon for holding an investment, and the role the investment will play in the portfolio as a whole.

In conducting an investment analysis of a mutual fund, for example, an investor looks at how the fund performed over time compared to its benchmark and to its main competitors. Peer fund comparison includes investigating the differences in performance, expense ratios, management stability, sector weighting, investment style, and asset allocation.

Determining Financial Needs for Projects

Add up costs

One-time costs may include such items as legal and professional costs for incorporating or registering your business; starting inventory; licence and permit fees; office supplies and equipment; long-term assets, such as machinery, a vehicle or real estate; consulting services; and website design.

Recurring expenses will include such items as salaries, rent or lease payments, raw materials, marketing costs, office and plant overhead, financing costs, maintenance and professional fees.

Once you’ve determined your initial and follow-on expenses, you will need to estimate how much money you will have at your disposal.

Calculate your financial resources

Estimate how much starting capital you will have and the amount of revenue you’ll be able to generate each month during the start-up period. To calculate the latter, research your potential market and industry averages to come up with realistic numbers.

Now, plug your estimated financial resources and your estimated expenses into a set of financial projections for your business. A quick examination of your projections will show if you’ll have a financial shortfall.

When you have educated yourself on what entails in the market, it’s time to determine what you will be spending on. Starting a business comes with a lot of expenses. Some of these are one- time costs and others may be recurring expenses. Examples of one-time costs include:

• Cost of registering and licensing your business. Getting the appropriate and legal backing is essential for the long-term of the business.
• Cost of Equipment. These are the machinery that will produce a bulk of your services.
• Office supplies
• Vehicle for transportation
• Office/Production Space

On the other hand, recurring expenses will include:

• Maintenance fees that will ensure your machine framework is functioning properly.
• Salaries for your workers. Whether you start with two employees or twenty, you need to have resources to pay them when due.
• Lease payments. If you lose your production space, your business suffers a great deal. It is extremely necessary to do all you can to maintain that space.
• Marketing costs are also recurring expenses. You will need to consistently get your product into the market by advertising through various means. You may use marketers or media.
• Cost of basic materials that you would be using should also be put into consideration.

Project financing: Advantages:

1. Non-Recourse: The typical project financing involves a loan to enable the sponsor to construct a project where the loan is completely ‘non-recourse’ to the sponsor, i.e., the sponsor has no obligation to make payments on the project loan if revenues generated by the project is insufficient to cover the principal and interest payments on the loan. In order to minimize the risks associated with a non-recourse loan, a lender typically will require indirect credit supports in the form of guarantees, warranties and other covenants from the sponsor, its affiliates and third parties involved with the project.
2. Maximise Leverage: In a project financing, the sponsor typically seeks to finance the cost of development and construction of the project on a highly leveraged basis. Frequently, such costs are financed using 80 to 100 percent debt. High leverage in a non-recourse project financing permits a sponsor to put less in funds at risk, permits a sponsor to finance the project without diluting its equity investment in the project and, in certain circumstances, also may permit reductions in the cost of capital by substituting lower-cost, tax-deductible interest for higher-cost, taxable returns on equity.
3. Off-Balance-Sheet Treatment: Depending upon the structure of project financing, the project sponsor may not be required to report any of the project debt on its balance sheet because such debt is non-recourse to the sponsor. Off-balance-sheet treatment can have the added practical benefit of helping the sponsor comply with covenants and restrictions relating to borrowing funds contained in other indentures and credit agreements to which the sponsor is a party.
4. Maximize tax benefit: Project financings should be structured to maximize tax benefits and to assure that all possible tax benefits are used by the sponsor or transferred, to the extent permissible, to another party through a partnership, lease or other vehicle.

Impact of Leveraging on Cost of Finance

Taking on debt, as an individual or a company, will always bring about a heightened level of risk due to the fact that income must be used to pay back the debt even if earnings or cash flows go down. From a company’s perspective, the use of financial leverage can positively or sometimes negatively impact its return on equity as a consequence of the increased level of risk.

Impact on Return on Equity

Return on equity is the rate of return on the shareholders “Equity of a company’s common stock owners. It measures a firm’s efficiency at generating profits from every unit of shareholders’ equity. Return on equity shows how well a company uses investment funds to generate earnings growth. It can be calculated using the following equation:

ROE = Net Income (After Tax) / Shareholder Equity

Leverage, Risk, and Misconceptions

The most obvious risk of leverage is that it multiplies losses. Due to financial leverage’s effect on solvency, a company that borrows too much money might face bankruptcy during a business downturn, while a less-levered company may avoid bankruptcy due to higher liquidity. There is a popular prejudice against leverage rooted in the observation of people who borrow a lot of money for personal consumption, for example, heavy use of credit cards. However, in finance the general practice is to borrow money to buy an asset with a higher return than the interest on the debt. Instead of spending money it doesn’t have, a company actually creates value. On the other hand, when debt is taken on for personal use there is no value being created, i.e., no leveraging.

There is also a misconception that companies enter a higher level of financial leverage out of desperation, referred to as involuntary leverage. While involuntary leverage is certainly not a good thing, it is typically caused by eroding equity value as opposed to the addition of more debt. Therefore, it is typically a symptom of the problem, not the cause.

Combining Operating and Financial Leverage

Operating and financial leverage can be combined into an overall measure called “Total leverage.” Total leverage can be used to measure the total risk of a company and can be defined as the percentage change in stockholder earnings for a given change in sales. In other words, total leverage measures the sensitivity of earnings to changes in the level of a company’s sales.

Methods For Finding Total Leverage

Total leverage can be determined by a couple of different methods. If the percentage change in earnings and the percentage change in sales are both known, a company can simply divide the percentage change in earnings by the percentage change in sales. Earnings can be measured in terms of EBIT, earnings before interest and taxes, or EPS, earnings per share. While EBIT can be determined by referencing a company’s income statement, we can determine earnings per share by dividing the company’s net income by it’s average price of common shares.

TL = {(Revenue – Variable Costs) / Operating income} * Operating Income / Net Income

A feasibility study is an assessment of the practicality of a proposed project or system. A feasibility study aims to objectively and rationally uncover the strengths and weaknesses of an existing business or proposed venture, opportunities and threats present in the natural environment, the resources required to carry through, and ultimately the prospects for success. In its simplest terms, the two criteria to judge feasibility are cost required and value to be attained.

A well-designed feasibility study should provide a historical background of the business or project, a description of the product or service, accounting statements, details of the operations and management, marketing research and policies, financial data, legal requirements and tax obligations. Generally, feasibility studies precede technical development and project implementation. A feasibility study evaluates the project’s potential for success; therefore, perceived objectivity is an important factor in the credibility of the study for potential investors and lending institutions. It must therefore be conducted with an objective, unbiased approach to provide information upon which decisions can be based.

Benefits of a Feasibility Study

There are several benefits to feasibility studies, including helping project managers discern the pros and cons of undertaking a project before investing a significant amount of time and capital into it. Feasibility studies can also provide a company’s management team with crucial information that could prevent them from entering into a risky business venture.

Feasibility studies also help companies with new business development, including determining how it will operate, potential obstacles, competition, market analysis, and the amount and source of financing needed to grow the business. Feasibility studies aim for marketing strategies that could help convince investors and banks that investing in a particular project or business is a wise choice.

TELOS is an acronym in project management used to define five areas of feasibility that determine whether a project should run or not.

• T – Technical: Is the project technically possible?
• E – Economic: Can the project be afforded? Will it increase profit?
• L – Legal: Is the project legal?
• O- Operational: How will the current operations support the change?
• S – Scheduling: Can the project be done in time?

Importance of Project Feasibility

The importance of a feasibility study is based on organizational desire to “get it right” before committing resources, time, or budget. A feasibility study might uncover new ideas that could completely change a project’s scope. It’s best to make these determinations in advance, rather than to jump in and to learn that the project won’t work. Conducting a feasibility study is always beneficial to the project as it gives you and other stakeholders a clear picture of the proposed project.

Benefits of conducting a feasibility study:

• Improves project teams’ focus
• Identifies new opportunities
• Provides valuable information for a “go/no-go” decision
• Narrows the business alternatives
• Identifies a valid reason to undertake the project
• Enhances the success rate by evaluating multiple parameters
• Aids decision-making on the project
• Identifies reasons not to proceed

Apart from the approaches to feasibility study listed above, some projects also require other constraints to be analyzed:

• Internal Project Constraints: Technical, Technology, Budget, Resource, etc.
• Internal Corporate Constraints: Financial, Marketing, Export, etc.
• External Constraints: Logistics, Environment, Laws, and Regulations, etc

Features of a feasibility study for a good project

A project feasibility study evaluates the following topics in project management:

• Time: How long do you think it’ll take to finish?
• Risk: What are the dangers of finishing this project? Based on the predicted rewards, is the risk worth the company’s money and time?
• Legality: Is the company well-equipped to complete the project in terms of technical resources?
• Budget: Is the organisation financially capable of completing the project, and does the cost-benefit analysis justify proceeding?
• Operational Feasibility: Is the project addressing the organization’s needs in its intended scope by resolving issues and/or capturing opportunities?
• Technical capability: Is the company well-equipped to complete the project in terms of technical resources?

Scope of Project Feasibility

Need Analysis

The realization of the need of the project is indicated in this head. This identified need may influence the company itself, another company, the government or public. The need is confirmed and evaluated by conducting preliminary study. A proposal is then developed that specify that how the need may be satisfied.

Process Work

The preliminary analysis performed to ascertain what will be needed to fulfil the need is included in the process work. The consultant who is an expert in the project area may perform the work. System models or prototypes are mostly involved in the preliminary study. The general characteristics of the process can be illustrated by using artist’s conception and scaled down models for technology oriented projects. The forecasting of the result before the starting of the actual project can be carried out by the simulation of the proposed system.

Engineering and Design

A thorough technical study of the proposed project is involved in this. Written quotations are got from subcontractors and suppliers as required. The capabilities of the technology are evaluated as required. If required, the product design must be performed at this time.

Cost Estimate

The estimation of project cost to an acceptable level of accuracy is included in this category. At this level of a project plan, levels of around -5% to +15% are common. Cost estimation includes both the initial & operating costs. Cost estimate document should also contain estimates of capital investment and of recurring and non-recurring costs. The sensitivity of the project plan to the estimated cost values is also viewed by conducting sensitivity analysis on the estimated cost values.

Financial Analysis

The analysis of the cash flow profile of the project is included in financial analysis. This analysis should contain sources of capital, rates of return, payback periods, inflation, breakeven points, sensitivity and residual values. It is important analysis in which it is ascertained that either the funds are available or not and also when the funds will be provided to the project. The economic and financial feasibility of the project is supported with the help of the project cash flow profile.

Project Impacts

The assessment of the impact of the proposed project is provided by this portion of feasibility study. Social, environmental, cultural, economic and political impacts may be some of the factors that how public views the project. The value added capacity of the project must also be evaluated. On the basis of the cost of the raw material used in manufacturing product and the price of the product, a value added tax can be evaluated. The tax so gathered can be considered as a contribution to government pockets.

Conclusions and Recommendations

The entire outcome of the project feasibility analysis should be covered in the ending portion of the project feasibility analysis. This may reflect the rejection or endorsement of the project. This portion of feasibility report must contain the recommendations on what should be done.