30 Project Appraisal: EconomicAnalysis

Vishal Kumar

1. Learning Outcome

Understand the meaning and concept of project appraisal
Understand the relevance of market and demand analysis
Understand the steps in market and demand analysis
Know about the demand forecasting and forecasting techniques

2. Meaning and Concept of Project Appraisal: In the words of Cary Rosen “In schools, getting one right out of one is an A whereas getting two right out of twenty is an F. In business, two for twenty is an A, whereas one for one is probably luck”.

Project appraisal means a detailed evaluation of the project to determine its economic, technical and financial viabilities. Project appraisal is a generic term that refers to the process of assessing, in a structured way, the case for proceeding with a project or proposal. It is the analysis of costs and benefits of a proposed project with a goal of assuring a rational allocation of limited finance resources amongst alternate investment opportunities with the objective of achieving specific goals.

Project appraisal is therefore, a process whereby the entrepreneur makes an objective and independent assessment of the various aspects of an investment preposition of a project idea for determining its total impact and also is liability. It saves the entrepreneur themselves from a number of problems encountered by them while establishing a new project. It involves careful, critical and cautious look at the project idea and analyzing its various components, in order to formulate an objective project in its totality. It is an analytical management aid.

Project appraisal involves systematic examination of technical, economic, managerial, financial, organizational and legal aspects of a project. It is the process through which opportunities become a project, in which the entrepreneur is willing to invest his time, money and other resources. So it is the process of transmitting information accumulated through feasibilities studies into a comprehensive form in order to enable the decision maker undertake a comprehensive appraisal of various projects and embark on a specific project or projects by allocating limited resources. Since risk is involved in all activities associated with the project, project appraisal aims at improving the quality of projects and their long term profitability, aims at minimizing the risk of lending by rectifying their weaknesses and improving their effectiveness by incorporating into them safeguards missed by the promoters because of their lack of knowledge or information.

In a consumer drive market consumer is the Rex. The exploration of the future market is the first step in establishing the profitability of a future project and to get a clear cut idea as to market share that is likely to be captured. This is what market and demand analysis does as put in other words. Market and demand analysis is to do with two significant dimensions of market opportunities. In other words, it concentrates on the likely aggregate demand for the product or service and the share of the market the firm is likely to share along with other players. These dimensions are very difficult but very important in project analysis.

3. Market and Demand analysis: Market and demand analysis is the managing the demand- its estimation and determining the extent to which it can be met with satisfaction to consumers and profit to the producers. In simple words whenever a project planning and implementing comes to surface, it begins with two aspects of demand. That is, what is the potential size of the market? And to what extent the project planner is capable of getting share in the market?

In simple words market analysis is concerned with one question that is ‘what would be the market share of the project under appraisal’ and demand analysis is concerned with one question that is ‘what would be the aggregate demand of the proposed product or service in future’. The first step in project analysis is to estimate the potential size of the market for the product proposed to be manufactured and get an idea about the market share that is likely to be captured. Demand and supply shall be on the long- term basis.

The market analyst requires a wide variety of information and appropriate forecasting method. The kinds of information required are:

Consumption trend in the past and present consumption level.
Past and present supply position.
Production possibilities and constraints.
Imports and exports.
Cost structure.
Structure of competition.
Elasticity of demand.
Distribution channels and marketing policies in use
Consumer behavior and requirements
Administrative, technical and legal constraints.

The study of present demand requires the following aspects:

Current purchases- what manufactured goods are being bought now, in what quantities and at what prices, by whom and for what purpose.
Not satisfied demand-it may be that the delivered price is very high or the product is not properly marketed or is not good quality.
Marketing facilities- whether proper marketing facilities exist and what are their capabilities and limitations.
Competition- the number of other firms involved in the production of that product and prices charged by them.

So to study the future demand we have to study the past trends of the product and relationship between the increase in incomes and the increase in demand for the product.

4. Steps in market and demand analysis: Market and demand analysis is very important for the success of the future project, so it is very essential that it should be carried out in an orderly and systematic manner. The various steps that are involved in the analysis of market and demand are as follows:

(1) Situational analysis as well as specification of objectives: The project analyst, may be entrepreneur himself, is expected to get relationship between a given product and its market presently available. The work start with base of an informal talk with customers, competitors, middlemen, dealers and even employees or someone who is directly or indirectly associated with the enterprise or enterprises. The existing company or companies have the past and present which is a rich source of valuable experience. In this regard, the analyst may get good deal of facts relating to customer preferences, purchasing power of customers, and the quantity they buy where they buy, when they buy and even why they buy? Such informal analysis sometimes generates enough data to measure the market and to find out the projected demand and revenues. If such an analysis seems to be reliable and enough and if time and cost considerations are there, sometimes an analyst can decide not to carry on a formal study. However, in most circumstances, a formal study is considered essential. For a formal study to be carried out, objectives have to be defined clearly and comprehensively. Objectives will help in generating the information relevant in forecasting the overall market demand and in assessing the projected future share of the market. Objectives are, generally, structured in the form of questions such as:

a. Who are the consumers?

b. How many consumers are there for that product?

c. What do they want

d. When do they want it?

e. Why do they want it?

f. How do they want it?

g. Where do they want it?

h. What quality is desirable?

i. How much can they spend?

j. What price is acceptable?

(2) Collection of market data: In order to answer the questions which are listed above, information may be obtained from two sources such as primary as well as secondary sources. Secondary information provides the base and the starting point for market and demand analysis. It indicates what is known and provides ways and hint for gathering information required for further analysis. Sources of collecting data include both internal and external sources. Major sources of information are primary and secondary data:

a. Primary data: Primary data can be defined as information that is collected first hand, generally, by original research tailor made to answer specific, current research questions. The major advantage of primary data is that the information is specific, relevant and up to date. But data collection from primary sources involves much time and cost.

b. Secondary data: secondary data is that data the information of which is collected for some other purpose and is thus, readily available. The advantages of primary data are the disadvantages of secondary data. As a rule, no research should be done without a search for secondary information first and secondary data should be used whenever available and appropriate. The important sources of secondary information used for market and demand analysis in India are as follows:

Census of India issued by Govt. of India.
National sample survey reports issued by cabinet secretaries and Govt. of India.
Plan report issued by planning commission.
Annual publication by central statistical organization.
Indian year book by minister of information and broadcasting.
Statistical year book issued by UNO.
Economic survey issued by ministry of finance.
Guidelines to industries by ministry of industrial development.
Annual survey of industries by CSO
Annual report of the development wing under ministry of commerce and industry.
Annual bulletin of statistics of exports and imports by ministry of commerce.
Techno-economic survey by national council of applied economic research.
Industrial potential surveys by IDBI.
The stock exchange directory by BSE
Monthly bulletin of RBI, etc and annual report on currency and finance by RBI.
Commodity reports and other studies of the Indian institute of Foreign trade.
Studies of economic division of State Trading Corporation.
Weekly bulletins of industrial licenses, import licenses and export licenses published by Government of India.
Internal management reports.
Consultant’s reports.
Government publications of chamber of commerce and industries, FICCI, Directorate of industries etc.
International information bureaus.
Financial papers and magazines.

Evaluation of secondary information: while secondary information is available economically and readily; its reliability, accuracy, and relevance for the purpose under consideration must be carefully examined. The market analyst should seek to know:

Person who collected the information and his objectives
Period in which information was collected and published
Size of target population
Size of sample chosen
Degree of sampling and non-sampling bias in information collected
Degree of misrepresentation by respondents
Accuracy of information edited, tabulated and analyzed.
Proper application of statistical analysis

(3) Conduct of market survey: When secondary data are not available, irrelevant or obsolete, the analyst must then turn to primary research. Sometimes secondary information need to be supplemented with primary information gathered through a market survey, specific to the project being appraised. Market survey may be census or sample survey. In census survey approach, the entire population or the universe is covered. Here the term population or universe is taken as collecting information from each and every respondent may be an individual or an organization. For example, we took the case of estimating demand and market share for the improved kitchen flour mill. To conduct the survey by census method we will have to cover the entire potential customers say in a state, or a region or all India on one hand and the existing units that are manufacturing the conventional kitchen flour mills, dealers and the other. Instead, sample survey can be resorted all the firms concerned. Each technique has its own merits and limitations. Census method is time consuming, costly. However, the information got is quite adequate and reliable and accurate. On the other hand, sample survey is less expensive and less time consuming.

The information sought in a market survey relates to one or more of the following aspects

Total demand and the growth rate of demand.
Demand in different segment of the market.
Income and price elasticity of demand.
Objectives of buying.
Buying plan and intentions.
Satisfaction with the existing products unsatisfied needs.
Attitudes towards different products.
Practices and preferences in the area of distribution.

Steps in conducting sample survey:

Following are the steps which are involved in conducting sample survey:

i) Define the target population: Defining of target population is of almost importance in clear and carefully studied manner as it is first step. The target population may be divided into certain segment with their features.

ii) Select the sampling technique and size: Sampling technique implies the type of sampling i.e. simple random sampling, cluster sampling, sequential sampling, stratified sampling, systematic sampling and so on. Another important aspect of sampling is size of it, which has greater and deeper bearing on the reliability and accuracy of estimates.

iii) Design the questionnaire: To collect the information from the respondents, the main instrument is questionnaire. Questionnaire is a sequential array of questions, designed in a way which is ideally suited to elicit information from someone who is administered the questionnaire.

iv) Recruitment and training of researchers: proper plan of recruitment and training is to be prepared and implemented. Great care is needed in recruiting the researchers and imparting the right kind of training to them.

v) Get information according to questionnaire from the target respondents: the respondents can be interviewed personally, or through mail or telephone. Each means is having its own merits and demerits.

vi) Scrutiny of information: Next step is to scrutinize the gathered information so that irrelevant or inconsistent data can be eliminated.

vii) Analysis and interpret the information: The collected information has no meaning unless, it is minutely analyzed and interpreted with due care. The data are to be tabulated as per the plan of analysis followed by strict statistical investigation wherever possible and needed. The analysis should be done by a properly qualified person having a background in Statistics and Economics.

5. Characterization of the Market

This step characterizes the market on the basis of information gathered. The market for the product or service can be described in term of clear cut characteristics based on the information gathered from secondary sources and through the market survey or primary sources. It can be described in term of the following.

6. Demand Forecasting

After collecting information about various aspects of the market and demand an attempt is to be made to estimate market demand for the industry. The first step in market forecasting is to assess the market potential. Market potential is the highest possible level of demand in a given environment. Market forecast is the projection of demand for the entire industry and this lead to the firm’s share and is called the sales forecasting. Thus, estimating sales or predicting the sales gives the base for the quantity and quality of production and base production figure are predicted, estimation can be made for each operations and the timely and sound decision can be taken. Therefore, forecasting means, demand forecast and indirectly the sales forecast.

7. Forecasting techniques

1. According to time duration: On the basis of time duration there are three types of forecast– short term, medium term, and long term.

Short term forecast: Short term forecast made for a very short period. Generally it covers a period of one month to twelve month i.e. one year. This type of forecast further divided into quarters or months for precision. The result achieved from this forecast is more accurate.
Medium term forecast: The time horizon for medium-term is between two to four years. It means more than one year to four years. The results achieved from these forecasts are likely to be less accurate as compared to short term forecasts but more accurate than long term forecasts due to time factor.
Long term forecast: Long term time horizon ranges over or beyond four years. It is a period of more than four years to fifteen years or can be extended more than in exceptional circumstances. The accuracy level of this type of forecast is minimum.

2. According to qualitative methods of demand forecasting: These surveys are conducted to collect information about consumer’s intention and their future purchase plan. This method includes:

Survey of potential consumers to elicit information on their intentions and plans.
Opinion polling of experts that includes opinion survey of market experts and sales representative, and their market studies and experiments.

1. Consumer survey: This method involve direct interview of the potential consumers. This could be done either by presenting a questionnaire personally before the consumers or by sending the questionnaire by post. In this method we can include direct interview, sample survey, and end use method.

2. Jury of executive opinion method: In this method, small numbers of top executives are requested to register their individual opinions relating to the probable amount of future sales. So the executive who are selected for giving the opinions are those who are fully aware of the market conditions, capabilities and the boons and bans of the industry. In this method market studies and experiment such as laboratory tests, test market or Delphi methods are to be conducted.

3. According to statistical methods of demand forecasting: Statistical method is very helpful in demand forecasting. It is used for long-term forecasting of demand. Statistical methods have certain advantages over the other methods such as

Estimation is based on the theoretical relationship between the dependent and independent variables.
Element of subjectivity is minimum in this estimation.
It is a scientific method.
It involves minimum cost as compare to other methods.
It is relatively more reliable.

Statistical method of forecasting involves the following techniques:

(1) Trend Projection Methods

(2) Barometric Methods

(3) Econometric Methods

(1) Trend projection method or Time series: Trend projection method is a classical method of demand forecasting. This method is concerned with the study of movements of variables through time. The use of this method requires a long and reliable time-series data. This method is used under the assumption that the factor responsible for the past trends in the variables to be projected for example sales and demand, will continue to play their part in future in the same manner and to the same extent in magnitude and direction. This assumption may be quite justified in many cases.

This method is also called Naïve forecasting or The projection of the Present Trend or Mechanical extrapolations or Quantitative method. There are three techniques of trend projection on the basis of time-series data.

Graphical method
Fitting trend equation or Least square method or Line of best fit.
Box-Jenkins method

(2) Barometric Methods: This method is also known as Leading (economic) indicator method or Lead Lag method. The Barometric method of forecasting follows the method meteorologist’s use in weather forecasting. They use barometer to forecast weather conditions on the basis of movements of mercury in the barometer. The basic approach of barometric technique is to construct index of relevant economic indicator and to forecast future trends on the basis of movements in the index of economic indicators. Use of barometric techniques is based on the idea that the future can be predicted from certain happenings in the present. Indicator used in this method are Leading indicators, coincidental indicators and lagging indicators.

(3) Econometric Methods: This method combines statistical tools with economic theories to estimate economic variables and to forecast economic events together with mathematical model building. The econometric methods are widely used to forecast demand for a product, for a group of products and for the economy as whole. An econometric model may be a

Regression method
Simultaneous equation method

8. Summary: Project appraisal involves systematic examination of technical, economic, managerial, financial, organizational and legal aspects of a project. It is the process through which opportunities become a project, in which the entrepreneur is willing to invest his time, money and other resources. So it is the process of transmitting information accumulated through feasibilities studies into a comprehensive form in order to enable the decision maker undertake a comprehensive appraisal of various projects and embark on a specific project or projects by allocating limited resources. Since risk is involved in all activities associated with the project, project appraisal aims at improving the quality of projects and their long term profitability, aims at minimizing the risk of lending by rectifying their weaknesses and improving their effectiveness by incorporating into them safeguards missed by the promoters because of their lack of knowledge or information. Market and demand analysis is to do with two significant dimensions of market opportunities. In other words, it concentrates on the likely aggregate demand for the product or service and the share of the market the firm is likely to share along with other players. These dimensions are very difficult but very important in project analysis.

Learn More

Suggested Readings:

Projects: Planning, Analysis, Selection, Implementation & Review, Prasanna Chandra, Tata McGraw-Hill Publishing
Project Management: A Managerial Approach, Jack R. Meredith, Wiley Publications
Project Management: A Development Perspective, Goyal B.B., Deep & Deep Publications.
Project Planning and Control, Mohsin M., Vikas Publishing House.
Project Management, Chaudhary, S., Tata Mc Graw Hill Publications.
Project Management, Maylor, Pearson Education
United Nations Industrial Development Organization, Guide to Practical Project Appraisal–Social Benefit Cost Analysis in Developing Countries, Oxford & IBH.

Points to ponder:

Project Appraisal:- Project appraisal is a process whereby the entrepreneur makes an objective and independent assessment of the various aspects of an investment preposition of a project idea for determining its total impact and also its liability.
Market and demand analysis: Market and demand analysis is the management demand, its estimation and determining the extent to which it can be met with satisfaction to consumers and profit to the producers.
Primary data: Primary data can be defined as information that is collected first hand, generally, by original research tailor made to answer specific, current research questions.
Secondary data: Secondary data is that data the information of which is collected for some other purpose and is thus, readily available