This article discusses briefly the importance of feasibility studies before you embark on a large scale project. Project feasibility can be split in two parts: commercial viability and technical viability. The focus of this article is around commercial viability and in particular, the use of discounted cash flows to make a decision on a project.
The benefits of this exercise include:
- Confidence that you have made the right decision to continue with the project.
- A decision making tool to evaluate one project against another.
- An understanding of the profitability.
- Once complete, there will be a good understanding of market conditions and trends.
- A prediction when the project will pay back it’s investment.
At DBC, we advice our clients using three key variables to help decide if the project should be attain final investment decision or not. These are:
1. Net Present Value
Present Value is defines as the value in the present of a sum of money, in contrast to some future value it will have when it has been invested at compound interest. By converting all future cash flows to present values, we can start to compare apples to apples. The sum of these converted cash flows gives the net present value or NPV. From this one can conclude the feasibility of the project. As a general rule: NPV positive means the project is feasible.
2. Internal Rate of Return
As defined by wikipedia:
“The internal rate of return (IRR) on an investment or project is the “annualised effective compounded return rate”
rate of return that sets the net present value of all cash flows (both positive and negative) from the investment equal to zero. Equivalently, it is the discount rate at which the net present value of future cash flows is equal to the initial investment, and it is also the discount rate at which the total present value of costs (negative cash flows) equals the total present value of the benefits (positive cash flows).”
3. Profitability Index
As defined in Wikipedia:
The Profitability index (PI), also known as profit investment ratio (PIR) and value investment ratio (VIR), is the ratio of payoff to investment of a proposed project. It is a useful tool for ranking projects because it allows you to quantify the amount of value created per unit of investment.
Below is an example of the three variables completed for a client project which gave the following calculations:
|Payback Period||3.5 years|
|Decision||Accept the Project|
Besides looking at the commercial viability of the project, it is advisable to understand the technical feasibility. This may include aspects like:
- Development of Technology used
- Production Technique
- Complexity of the project
- Location of the project
- Ability for the system to solve the problem.
If you are interested in having your new project or investment opportunity analysed to asses feasibility, please reach out to us at firstname.lastname@example.org