Feasibility Study
Feasibility Study
Feasibility Study
The investment outlay in any project is expected to bring the desired return or benefits in future
for resource providers. If the financial resources were abundance, it would be possible to accept
several investment proposals which satisfy the norms of approval or acceptability. Since, we are
sure that resources are limited (scarce), a choice has to be made among the various investment
proposals by evaluating their comparative advantage. This would help investors to select the
relatively superior proposals keeping in view the limited available resources. For this purpose,
we have to develop some evaluating techniques for the appraisal of investment proposals of
Tewodros Dagnachew General Export & whole business.
The planed business proposal suggested by the business owner is associated with long term
financing. There is no hard and fast rule to define it, but by common practice and accordance
with the financing policies, practices and regulations of the financial institutions and banks a
period of ten years and above may be treated as long period. The decisions related to long-term
investment is also known as capital budgeting techniques. It is important to properly evaluate the
feasibility of capital budgets because of the following reasons:
1) The long term investment decisions are the vehicles of a company to reach the desired
destiny of the company. An appropriate decision would yield spectacular results whereas a
wrong decision may upset the whole financial plan and endanger the very survival of the
firm. Even firm may be forced into bankruptcy.
2) Long term investment decisions require huge amounts of funds and imply permanent
commitment. Once you invest in the form of fixed assets it is not easy to reverse the
decision unless you incur heavy loss.
3) Long term investment decision has its effect over a long period of time span and inevitably
affects the company’s future cost.
4) Investment decision are among the firm’s most difficult decisions. They are the predictors
of future events which are difficult to predict. It is a complex problem investment. The cash
flow uncertainty is caused by economic, political, social and technological forces.
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6.1 Types of Long Term Investment
The long-term funds are required for the following purposes:
Expansion: A company adds capacity to its existing product lines to expand existing operations.
For example, a manufacturing unit producing one hundred thousand units per year, If it intends
to double the output by two hundred thousands, this will obviously increase the need for funds
for acquiring fixed and current assets.
Diversification: Sometimes the management of a company may decide to add new product line
to the existing product lines.
Replacements: vehicles used in a transportation service may either wear out or may be rendered
obsolete on account of new technology. The business capacity of the enterprise and its
competitive ability may be adversely affected. Extra funds are required for modernization or
renovation of the entire business. The investment obviously is going to be long terms.
Research and Development: There has been an increased realization that the efficiency of
production and the total operations can be improved by application of new and more
sophisticated techniques of production and management. To acquire the technology huge funds
are needed.
To this end, Tewodros Dagnachew General Export & whole sales business is planning to expand
the current capacity through requiring additional working capital from Commercial Bank of
Ethiopia in the form of loan.
Initial Investment: The total amount of cash required to buy various assets like land, buildings,
plant, machinery, equipment, etc and there installation expenses have to be estimated. In addition
to fixed cost, the cost of maintaining stocks, contingency reserves to cover the cost of supporting
the additional receivables. Benefit of credit from suppliers will have the effect of reducing the
quantum of additional working capital required.
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Subsequent Investment: The cost of maintenance, replacement and updating are to be treated as
outflows during the period in which they are expected to be incurred.
Some times the plant assets may have value for the enterprise at the end of the life of the project
or there may be some anticipated sales value of the plant. Such amount is to be treated as an
inflow at the end of the life of the project.
The calculation of annual cash flows in investment appraisal plays a key role. The computation
of cash flows is a simple task. The following areas are to be considered.
Additional Sales revenue: This is going to be the function of sales any wrong calculation in this
regard will bear impact on the investment opportunity. Care has to be taken to forecast accurately
and the additional revenue generated by the investment should be taken into account. The
investment must also result into the reduction of operating cost either by modernization or
replacement models where the savings benefit or cash flows will increase. In simple terms
annual cash flow is equivalent to net profit after tax plus depreciation. Algebrically,
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Project Feasibility Appraisal Methods
There are two important methods of evaluating the feasibility of investment proposals
Traditional methods
This is one of the widely used methods for evaluating the investment proposals. Under this
method the focus is on the recovery of original investment at the earliest possible. It
determines the number of years to recoup the original cash out flow, disregarding the salvage
value and interest. This method do not take into account the cash inflows that are received
after the pay back period. There are two methods in use to calculate the pay back period
1) Where annual cash flows are not consistent vary form year to year
B
P=E+ C
E stands for number of years immediately preceding the year of final recovery.
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Where the annual cash flows are uniform
Original Investment
PB = Annual cash flows
Based on Appendex Tewodros Dagnachew General Export & whole sales business’s pay back
period is computed as follows
Year3------- 48,420,633.47
From this we can deduce that Tewodros Dagnavhew Export & Whole sale business can recap its
initial investment within 3 years of operation.
1
2 (Initial cost of plant – salvage value)
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Total of annual profits
Average profits = Number of years
The ARR is compared to the predetermined rate. The project will be accepted if the actual ARR
is higher than the desired ARR. Otherwise it will be rejected.
Based on Appendix Tewodros Dagnachew General Export & whole sales business’s Accounting
Rate of Return is Computed as follows;
= 160,011,648.04 / 70,702,402.54
=22.6%
This concept is based on the time value of money. The flow of income is spread over a few
years. The real value of Birr in your hand today is better than value of birr you earn after a year.
The future income, therefore, has to be discounted in order to be associated with the current out
flow of funds in the investment. Two methods of appraisal of investment project are based on
this concept. These are net present value and internal rate of return method.
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Based on Appendix Tewodros Dagnachew General Export & whole sales business’s Net Present
Value is Computed as follows
= 258,727,673.33 -112,501,451.63
= 146,226,221.70
Since the NPV of the project Tewodros Dagnachew General Export & whole sales business is
positive , it should be accepted
=258,727,673.33/112501451.63
=2.3 times
Since the profitability index of Tewodros Dagnachew General Export & whole sales business is
greater than zero, the project is feasible to be implemented.
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