Overview ON financial feasibility study

Financial feasibility study - definition, importance and method of preparation


Definition of feasibility study:

What is a feasibility study?

The Feasibility Study can be defined as a series of specialized, interrelated and integrated studies conducted in advance (in advance) on investment projects to be implemented from the time of the project's thinking until the project reaches the liquidation stage in order to ensure the validity of investment projects to achieve specific results. In other words, these are the studies that need to be carried out to verify that the outputs of the investment project exceed the resources allocated to it, and that those outputs correspond to the investor's motivations and trends.

It should be noted, however, that there are several conventions that call for feasibility studies and these conventions, although different in their title, do not differ in substance or substance and income within those terms: Project Evaluation, Investment Appraisal Investment Assessment, Project Economics Economics.


Steps to prepare the feasibility study for any project

First: To carry out the preliminary feasibility study

Preliminary feasibility studies are quick exploratory studies aimed at reaching a first judgment on the likelihood of achieving the investment project for which we are conducting a feasibility study for its objectives. In other words, it is intended to verify that there are indications that the project can be successful. If these studies result in the absence of substantial impediments to the implementation of the investment project or the availability of prospects for success, detailed feasibility studies are prepared in their various dimensions and there are economic justifications for the work of these detailed studies.

If such studies result in the lack of the possibility of success of the project for personal reasons that are difficult to interpret or for objective reasons as discussed in the initial feasibility study article, feasibility studies will stop there, and the investor can study other ideas if he wishes to do so.

There is no justification for final feasibility studies that are often costly for an inappropriate investment idea or for an investment project that is not viable.

The initial feasibility study helps the investor to filter the projects and investment ideas that he has to reach the idea that is worth the time, effort and money in a detailed feasibility study.
Second: The stage of preparation of a detailed feasibility study:

We provide detailed feasibility studies on the marketing, technical, organizational and financial basis of the investment project decision, as several final feasibility studies are conducted on investment projects selected through the initial feasibility study and proven to be feasible, and these studies are carried out through the following partial stage:

A. The stage of the marketing feasibility study.
B. Technical and engineering feasibility study phase.
C. The stage of administrative and organizational feasibility study.
D. The stage of studying the financial and economic feasibility and assessing (estimating) commercial (private) profitability.


The financial feasibility study is meant:


The financial feasibility study means this aspect of the feasibility study, which aims to ensure the success of the investment project commercially, i.e. from the investor's point of view.

The purpose of defining that objective requires the preparation of a set of feasibility studies that the financial feasibility study must obtain, and must insist on completing, since without it it cannot begin preparing a financial feasibility study, these studies are: marketing feasibility study, technical feasibility study, organizational and administrative feasibility study.
The investment project is considered financially viable (commercial) if it gives a return on the money invested at a rate higher than the rate of return that can be obtained from the use of money in alternative areas. The project is also considered commercially viable if capital costs can be recovered within the period specified by investors and the shorter the duration, the more useful the project will be.


The importance of the financial feasibility study:


The importance of the investment project's financial feasibility study lies in the fact that without it it is not possible to quantify the amount of funds required to establish and operate it, and to distribute them in time as needed.

Without it, it is not possible to determine the best sources of access to these funds, which may carry high financing costs, which would have a negative impact on the return on owner-owned capital.

In addition, without a financial feasibility study, it is not possible to estimate the accounting profit of the owners, determine the savings or burden of foreign exchange as a result of the establishment and operation of the investment project, and determine the profitability of the project to the community.


Data and information needed to conduct a financial feasibility study:


In view of the fact that the financial feasibility study has been seen as an extension of the marketing feasibility study, the technical feasibility study, the organizational and administrative feasibility study, it is based primarily on the data set and the information generated by those studies, or in other words, based on the results of those studies, the outputs of those studies represent part of the financial feasibility study input.

Based on the above, the preparation of a financial feasibility study requires the availability of the following data and information:

First: General data and information on the investment project.
Second: Data and information on the results of the marketing feasibility study.
Third: Data and information on the results of the technical feasibility study.
Fourth: Data and information on the results of the organizational feasibility study and management.
Fifth: Financial data and information.

The financial feasibility study examines and analyses past data and is expressed in several forms of estimated financial statements. Linking the different stages of determining the feasibility of the investment project with a view to determining the amount of capital required for it, i.e. estimating the amount of investment required for the project and identifying the uses of the invested funds, as well as determining the period needed to implement the investment stages, identifying sources of financing, estimating the expected return, savings and all other items in the form of expenses and income as a result of the project implementation.


The components of the financial feasibility study and how to prepare it:

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The financial feasibility study includes several main aspects, the most prominent of which are:

First: Determining the projected investment costs of the investment project:
That is, determining the expected capital expected capital for the project or the expected investment spending for it. Investment spending is at any cost that is spent and not recovered within a single fiscal period. Therefore, for the new investment project, it includes all the amounts spent from the beginning of the project's thinking, during its construction to the start-up period.

Investment spending items representing outflows can be divided into:

1. Fixed Assets Costs:

It represents the capital required to establish an investment project, i.e. necessary to form its fixed assets of: land, buildings, machinery and equipment, transportation, spare parts, furniture and others. These costs include purchase, arrangement, shipping, transportation and testing costs ... Etc.

2. Formation Costs pre-opening expenses:

It represents the capital required to establish the project, i.e. the amounts spent on pre-construction investment projects and we do not convert to assets and include the costs of feasibility studies, fees for licensing the construction of the project, amounts paid for the purchase of patents or manufacturing rights, administrative expenses at the time of construction, and the costs of training workers ... And others.

3. Working capital:

I.e. the capital required for operation, i.e. the pool of funds needed to purchase raw materials and other production supplies needed to operate the project, as well as the amounts needed to pay workers' wages, fuel and other operating supplies and then sales expenses, from the start-up and throughout the production period, sale and collection, i.e. until the production value is collected again, in other words, the working capital is the total amount of funds needed at the start-up, which ensures regular operation during the first production cycle, which includes a period of Production, sale and collection processes. The working capital is calculated on the basis of the availability of data on:

The amount of materials to be kept as a minimum of inventory and until a future replacement is provided to ensure operation.

- Operating expenses during the first round of production, which includes the period of production, sale and collection as previously shown.

Second: Identify the sources of financing of investment costs and the burdens involved:

The investment project in its financing of investment costs depends on what the owners offer and what others offer (banks, suppliers, ... Etc.), the project's reliance on borrowed funds or debt financing entails two types of obligations: loan installments and interest payments, known as fixed or debt service burdens. Part of the investment costs are also incurred by the owners' funds, with another burden of the return lost to the owners as a result of the investment of those funds in this project (opportunity cost).

Third: Identifying elements of investment costs due to recovery:

There are two views in this regard:

First opinion: Says that all investment costs spent in the construction years must be recovered during the years of operation, including land and working capital.

Second opinion: The elements of investment costs and recovery are:

A. All fixed assets except land.
B. Pre-opening expenses.

That is, the investment costs and recovery benefits are based on this irrigation =

Total investment costs (land + working capital).

This view excludes land and working capital because they represent existing amounts without the need for recovery.

This view also excludes the unused portion of the error reserve in the estimates, if any, within the investment cost estimates. For the record, the wrong reserve in the investment cost estimates is between 5%20% of the value of the investment costs, and the duration of this reserve is the start of spending on the project until the start-up.

The previous equation can be otherly formulated as follows:

Investment costs and recovery = loans + part of the ownership base

The refore, the ownership rule is due to be recovered = ownership rule (land + working capital + the unused portion of the error reserve in estimates).

Fourth: Identify the sources on which the investment project is based in recovering investment costs and paying obligations:
Investment projects to recover the money invested for owners depend on the following three sources:

A. Premiums (provisions) depreciation of fixed assets.
B. Distributable surplus after covering all burdens, including taxes.
C. The sale price of fixed assets at the end of their (default) life expectancy.

Fifth: Identifying indicators of governance on the financial and economic feasibility of the project:

Indicators used to evaluate investment projects and judge their financial and economic feasibility can be divided into:

1. Indicators that ignore the idea of the time value of money and include:

A. Recovery period

See also: Wide range of InstaForex technical indicators.

It means the period of time required to recover the initial cost of investment from cash flows that are sources of

Recover this investment.
This indicator is based on the preference of the investment project if it is found that the investor will be able to recover the funds invested in it within a specified period, sometimes called the liquidity criterion on the basis that it recommends the implementation or approval of projects if it can be recovered and thus quickly obtain the funds spent on it.
Some investors use it on the grounds that it ensures that their project funds return quickly, which is required if they are to operate under uncertain long-term conditions.

In cases where future conditions are uncertain, which is often the case, it is important to recover funds invested in the shortest possible period. If the investment project continues to give income after this period, it has made profits to its owners, but if the opposite happens, the owners will have recovered their money in full.

To apply this indicator, data must be available on: the amounts to be spent on the investment, i.e. the amount of funds to be invested, the total depreciation value, and the amounts expected to be received by the project from this investment or the net profit that will be achieved after the implementation of the project.
Recovery period = Investment costs due to be reimbursed / Average annual profit + depreciation


Note:


Definition of depreciation: The process of distributing the cost of fixed asset over the years benefiting from its services, the depleted part of the fixed asset cost in order to obtain income is called fixed asset depreciation. For more information, I would advise you to see this separate article entitled
Depreciation of fixed assets - definition, types and methods of depreciation and difference between them
The time value of money: The time value of the money is based on the constant fact that the value of the pound obtained now exceeds the value of the pound obtained in the future as a result of the inflation that exists in the economy, the higher the inflation rate in the economy, the lower the future value of the money than the current value of the money.

The concept of future value of money: When we talk about the future value we talk about the value that is calculated using the compound interest rate, not using a simple interest rate. That is, the future value of the asset at the end of the period will be calculated by calculating the interest on the principal of the amount plus interest on interest (interest on the interest amount) during the period from the date of the deposit to the end of the period.

Present Value: When making financing or investment decisions, it is useful to determine the value of funds at present for all future cash flows. When calculating the current value, the expected future cash flows are deducted using the appropriate discount rate depending on the nature of the project whose returns are assessed. This rate may be the prevailing market interest rate or interest rate required when evaluating investment alternatives in the form of stocks and bonds, or the cost of capital may be when evaluating an investment project.


Recovery period defects


The recovery period indicator can be used to trade-offs between investment proposals but only provided that those proposals have the same period and that their overall annual profit is very close.

Although this indicator is easy to calculate and apply, and although it is appropriate in the case of proposals that are subject to rapid technological development, and in the case of multiple investment opportunities and scarce resources, and although it is logical at first glance, there are also a set of logical objections that make many investors reluctant to rely on it when evaluating investment projects, these objections are:

A. The use of the recovery period as a basis for approving or rejecting investment projects necessarily leads to a preference for investing funds in a commodity and excludes any suggestion to invest in construction, renovations or expansions, as directing funds towards the purchase of goods ensures that they are recovered within a shorter period than if they were invested in any other area.
B. It is a financial indicator that ignores the time value of the money, and does not take into account the life of the project, ignoring what happens to it after the end of the recovery period.

A. The typical recovery period is subject to personal discretion, nor has it reached the risk of non-refundable funds spent, as long as this is done in the future, the expected income cannot be confirmed, and continuity after the first year cannot be confirmed either. The investment project may not generate any revenue after the first year.

On the basis of the above, a decision must not be taken to accept or reject the investment project on the basis of the period of recovery of its capital costs only as a secondary indicator in the selection of investment projects.

B. Average rate of return:

This method is indicated if cash flows are used at an average rate of return, but if the accounting net profit is used, the method is the accounting rate of return. The average return is calculated in three steps:

1. Determine the average net cash flow or average net accounting profit achieved by the project during the operating years, and calculates the average net collection during all years of operation and divided by the number of years of operation.

2. Determining the total capital invested in the project, which means the total capital invested in the project or the capital invested from the owners of the owned capital.

3. Calculating the average rate of return (or accounting rate of return) =

Average net cash flow or average net accounting profit/capital invested in the project
The decision rule, if using a method or method, average rate of return (or accounting rate of return) takes the following form:

* In the case of a single project study to decide whether to accept or reject a decision: a fixed standard average return rate (or accounting rate) must be available in advance and if the average project return rate (or accounting rate of return for the project) is greater than the standard rate of project acceptance, and vice versa, and if the average project return rate (or accounting rate of return) is equal to the standard rate, other evaluation methods are based on a project decision.

* If several separate projects are studied to rank by preference: preference is given in the order of the project that achieves the highest average rate of return (or the highest rate of accounting return), followed by the project with a lower rate of return and so on.

* In the case of studying several mutually opposing projects to select one for implementation: a project that achieves the highest average average rate of return (or the highest rate of accounting return).


Disadvantages of the average rate of return method:


1. The use of the method may result in the acceptance of proposals that contribute less to maximizing the wealth of owners and rejecting any proposals that contribute more to maximizing the wealth of owners.
2. Ignore the concept of the time value of money.
3. This method requires equal age of projects in the place of trade-off, where the return of 20% per annum in 10 years cannot be compared with a return of 15% per annum over 20 years, for example.
4. This method neglects the fact that profits or flows can be reinvested.

2. Indicators that recognize the time value of money:

It includes:

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A. Net Present Value for the project or return from the project:

This indicator takes into account the time value of the money and summarizes the way in which this indicator can be found in calculating the present value of the projected annual flows of the investment project at a certain discount rate, i.e. on the basis of deducting those flows at an interest rate chosen to be in line with the degree of risk involved in the investment project. The current value can be defined as the value resulting from the deduction of annual cash flows (inward, out) each year, during the life expectancy of the project according to a discount rate set in advance in the light of the current interest rate on medium-term deposits in banks or the interest rate of long-term loans in the market as in some countries, and the discount rate reflects the minimum acceptable to entrepreneurs for investing their money. The remaining value of assets at the end of the life of an economic project such as buildings and land is taken into account as a cash stream within, and in turn the replacement of new assets during the life of the project must be taken into account as outflows.

The net present value of the project is defined as the difference between the present value of inflows and the present value of outflows. If the present value of inflows is greater than or equal to the present value of outflows, the project is considered acceptable, otherwise it must be dismissed in the event of the opposite, i.e. when the net present value of the project is negative, i.e.,:

Net project value = present value of inflows, present value of outflows

B. Internal rate of return:

It is sometimes called the real rate of return or the expected rate of return, and is the rate at which investment costs and the present value are matched by the expected surplus.

This rate is determined by calculating the present value of inflows based on a hypothetical rate of return and comparing output with total invested funds (investment assets), if it turns out that the output increases, the current value is recalculated at a higher rate and accounts are repeated at other rates until the rate at which the current values are equal to the total amounts representing the cost of the investment or the investment asset.

The Internal Rate Index simply distinguishes the results achieved in order to channel funds to a particular investment project, and compare these results with the cost of obtaining funds.

If the expected rate of return is lower than the cost of funds, the project is advised to reject it because it will result in the investor incurring losses equivalent to the difference between the rate of return and the cost of financing and vice versa. It also benefits in the downward and upward arrangement of investment proposals based on the difference between their respective expected internal rate of return and the cost of financing, and thus the choice of the best project.


Analysis of the results of the financial feasibility study:


It became clear from the foregoing that the financial feasibility study is primarily based on the outputs of both the marketing feasibility study and the technical feasibility study.

It was also found that the financial feasibility study was primarily aimed at evaluating the investment project proposed from the private wind vision, i.e. its commercial assessment by the investor or the group of investors intending to undertake this project by relying on a set of criteria or indicators: some ignored the time factor and others were careful to take into account this fundamental factor, which has a decisive impact on determining the feasibility of the investment or not, and in the differentiation between investment proposals.

In order to achieve the objective of the financial feasibility study, a range of financial alternatives are required, the most important of which are:
First: The accounting investment cost table (book) distributed over the years of construction.
Second: the table of the proposed funding structure for the project.
Third: The table of sources used to recover the capital costs of the project or the cash flows involved in the project.
Quarterly: The project's estimated business results schedule over the years of operation.
Fifth: The scale or project of the financial center of the project.

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