Feasibility Analysis

1. Feasibility Analysis

2. Feasibility Analysis • System request is reviewed by approval committee • Based on information provided, project merits are assessed. • Worthy projects are accepted and an additional investigation – the feasibility analysis is undertaken.

3. Feasibility Analysis • Detailed business case for the project • Economic • Technical • Operational • Schedule • Legal and contractual • Political • Feasibility is reassessed throughout the project

4. Economic Feasibility • Cost – Benefit Analysis • 1Determination of cost and Benefits • Tangible Benefits • -Can be measured easily • Examples • Cost reduction and avoidance • Error reduction • Increased flexibility • Increased speed of activity • Improved management planning and control • Opening new markets and increasing sales opportunities

5. Economic Feasibility • Intangible Benefits • -Cannot be measured easily • Examples • Increased employee morale • Competitive necessity • More timely information • Promotion of organizational learning and understanding

6. Economic Feasibility • Determine Costs • Tangible Costs • Can easily be measured in rupee terms • Example: Hardware • Intangible Costs • Cannot be easily measured in terms of money • Examples: • Loss of customer goodwill • Loss of employee morale

7. Economic Feasibility • 2 Assign Cost and Benefit values • Difficult, but essential to estimate • Work with people who are most familiar with the area to develop estimates • Intangibles should also be quantified

8. Economic Feasibility • One-Time Costs • Associated with project startup, initiation and development • Includes • System Development • New hardware and software purchases • User training • Site preparation • Data or system conversion

9. Economic Feasibility • Recurring Costs • Associated with ongoing use of the system includes: • Application software maintenance • Incremental data storage expense • New software and hardware releases • Consumable supplies • Incremental communications

10. Economic feasibility • Cost-Benefit Analysis Prior to erecting a new plant or taking on a new project, prudent managers conduct a cost-benefit analysis as a means of evaluating all of the potential costs and the revenues that may be generated if the project is completed. The outcome of the analysis will determine whether the project is financially feasible, or if another project should be pursued.

11. Economic Feasibility • Time value of money (TVM) • The idea that money available at the present time is worth more than the same amount in the future • Value of money decreases with time • Discounted Cash Flow – DCF • A valuation method used to estimate the attractiveness of an investment opportunity. Discounted cash flow (DCF) analysis uses future free cash flow projections and discounts them (most often using the weighted average cost of capital) to arrive at a present value, which is used to evaluate the potential for investment. • If the value arrived at through DCF analysis is higher than the current cost of the investment, the opportunity may be a good one.  

12. Present Value – PV • The current worth of a future sum of money or stream of cash flows given a specified rate of return. • Future cash flows are discounted at the discount rate, and the higher the discount rate, the lower the present value of the future cash flows.  Also referred to as "discounted value".

13. Present Value – PV • PV of Rs. 1500/- at 10% interest at the end of 4th year: • PV = 1500/(1+0.1)4 = 1500/1.61 = 1,029.39/- Year fv discount pvcpv 1 1500 .098 1363.63 1363.63 2 1500 .086 1239.67 2603.30 • 1500 .751 1127.82 3731.12 • 1500 .683 1027.39 4758.51

14. Net Present Value • Takes into account the fact that money values change with time • How much would you need to invest today to earn x amount in y years time? • Value of money is affected by interest rates • NPV helps to take these factors into consideration • Shows you what your investment would have earned in an alternative investment regime

15. Net Present Value • Project A costs Rs.10,00,000 • After 5 years the cash returns = Rs.100,000 (i.e.10%) • If you had invested the Rs.10,00,000 into a bank offering interest at 12% the returns would be greater • You might be better off re-considering your investment!

16. Net Present Value • The principle: • How much would you have to invest now to earn Rs.100 in one year’s time if the interest rate was 5%? • The amount invested would need to be: Rs. 95.24 • Allows comparison of an investment by valuing cash payments on the project and cash receipts expected to be earned over the lifetime of the investment at the same point in time, i.e the present.

17. Net Present Value Future Value PV = ----------------- (1 + i)n Where i = interest rate n = number of years • The PV of Rs.1 @ 10% in 1 years time is 0.9090 • If you invested 0.9090p today and the interest rate was 10% you would have Re.1 in a year’s time • Process referred to as: ‘Discounting Cash Flow’

18. Net Present Value • Cash flow x discount factor = present value • e.g. PV of Rs.500 in 10 years time at a rate of interest of 4.25% = 500 x .6595373 = Rs.329.77 • Rs.329.77 is what you would have to invest today at a rate of interest of 4.25% to have Rs. 500 in 10 years time • PVs can be found through valuation tables (e.g. Parry’s Valuation Tables)

19. Payback Method • Payback period: The length of time taken to repay the initial capital cost Requires information on the returns the investment generates • e.g. A machine costs Rs. 600,000 • It produces items that generate a profit of Rs. 5 each on a production run of 60,000 units per year • Payback period will be 2 years

20. Payback method • Payback could occur during a year • Can take account of this by reducing the cash inflows from the investment to days, weeks or years Days/Weeks/Months x Initial Investment Payback = ------------------------------------------ Total Cash Received

21. Payback Method • e.g. • Cost of machine = Rs. 600,000 • Annual income streams from investment = Rs. 255,000 per year • Payback = 36 x 600,000/765,000 • = 28.23 months • (2 yrs, 6¾ months)

22. Accounting Rate of Return • A comparison of the profit generated by the investment with the cost of the investment Average annual return or annual profit • ARR = -------------------------------------------- Initial cost of investment

23. Accounting Rate of Return • An investment is expected to yield cash flows of Rs.10,000 annually for the next 5 years • The initial cost of the investment is Rs.20,000 • Total profit therefore is: Rs.30,000 • Annual profit = Rs.30,000 / 5 = Rs.6,000 ARR = 6,000/20,000 x 100 = 30% A worthwhile return?

24. Discounted Cash Flow • A firm is deciding on investing in an energy efficiency system. • Two possible systems are under investigation • One yields quicker results in terms of energy savings than the other but the second may be more efficient later • Which should the firm invest in?

25. Discounted Cash Flow – System A

26. Discounted Cash Flow – System B

27. Discounted Cash Flow • System A represents the better investment • System B yields the same return after six years • the returns of System A occur faster and are worth more to the firm than returns occurring in future years even though those returns are greater