IS IT PROFITABLE? – FEASIBILITY STUDIES FOR INVESTMENT FINANCING, David Lythgoe, Halifax Consulting Beograd

Why is a feasibility study needed?

For a municipality considering new infrastructure investments, it is important to make rational, profitable and politically acceptable investment decisions. Nowadays, new investment also often means convincing a bank to provide credit at reasonable rates.

To be sure of this, the project’s feasibility needs to be studied. A good study takes a systematic look at all of the key variables and presents analysis in an accessible form.

The right study clarifies the risks and returns of a project, with the following advantages:

§ Financiers can reduce the interest rates they charge – fewer unknowns, lower rates.

§ A better case can be made for investment decisions, minimising the risk of embarrassing setbacks.

§ Different potential investment projects can be directly compared, allowing easier choice between alternatives and justification of decisions with hard facts.

§ Elements will usually emerge that allow the project design to be improved.

§ Policy decisions can be based on solid arguments, and more easily explained to citizens.

Any serious credit provider will require such a study before providing major loan facilities. The feasibility study is not an optional extra, but a key element in investment financing. In short, it provides:

§ security

§ improvement

§ cheaper finance.

When should the study be made?

The study should be made at the stage of a conceptual project.

§ The project should be clarified so that it consists of a cohesive idea, not just a group of unrelated wishes. There should be clarity over the objectives (what results the project should achieve), the activity plan for achieving them and the resources required.

§ If possible, potential alternative ways of achieving the objectives should be examined, or at least listed.

§ The consequences for all people and institutions involved should have been considered.

§ There must be enough detail to allow good cost estimates, and so that all of the positive and negative consequences can be foreseen.

The study should not wait for a detailed project:

§ A main project costs a considerable sum. If the study shows the project to be unprofitable, or that other variants are better, this will be lost.

§ A main project takes considerable effort. It risks building commitment to one particular form of the project, when the best form is not yet established. Such commitment can be expensive and dangerous, leading to irrational investments, to loss of funds and face.

If possible, those who are to conduct the study should be involved from the outset, so that the development of the conceptual project can be guided. This allows investigation of alternatives at varying and appropriate levels of detail, avoiding unnecessary work.

What does the study contain?

This depends partly on the project and the situation, but some elements are common to all studies.

§ General background assessment

§ Demand analysis - will your potential users really want to buy the product and can they actually pay for it? This is often done through surveys of potential customers and cost comparison with alternative ways of satisfying the same needs

§ A technical assessment of the proposed project – a technical second opinion by an independent expert

§ Evaluation of technical alternatives, from technical and cost-effectiveness viewpoints

§ Recommendations for additional measures to enhance or protect the investment

§ Environmental and social impact analysis, permitting procedures etc.

§ Review of investment costs

§ Analysis of the investor’s creditworthiness and its likely development over the project cycle

§ Analysis of the investment management structure, financial soundness, operational efficiency, ability to collect debts etc.

§ Financial and economic cost-benefit analysis of the project – how profitable is it, to the company and to society? The financial analysis looks at profitability for the company, but if the wider social benefits are large enough, it may be in the society’s interest to subsidise the company. Both aspects need clarifying.

§ Analysis of sensitivity to investment cost over-runs, material cost fluctuations and revenue changes – what will happen if…..?

§ Recommendations for price-setting and price policy structure

§ Sustainability / affordability analysis – can it be maintained over the years without additional use of resources, or will it require additional measures or inputs?

How much does it cost?

The cost of a feasibility study varies widely according to the type and size of the project. However, as a rule of thumb, ½% - 1½ % of the investment sum is a typical level.

This sum is an integral part of the project development costs. Project development and management costs (conceptual project, main project, management and supervision, auditing) often amount to some 12-15% of the investment. This cost is an insurance that the investment will be carried out professionally, and that the other 80-90% will not be wasted. The feasibility study is an integral part of the wider investment management process.

Just as the technical project costs assure high technical quality, the cost of the study assures a technical-economic quality. It is this careful, rational approach from the beginning that can save far larger sums through avoiding mis-investment and optimising many aspects of your project.

Who should do it?

A feasibility study should be carried out by an independent entity, one that has no interest in the outcome of the study. This is essential to avoid distortion of the results, and to provide credibility in the eyes of third parties such as credit providers. Such a service can most effectively be provided by an independent consultant experienced in the way of thinking of financing institutions.

For this purpose, you should provide a task description (terms of reference) that avoids any pressure for the study to show a positive result. If you engage a consultant to sell your project, (s)he will not make the objective appraisal that you need.

Credit institutions will often be convinced not only by the study’s content, but also by the reputation of the provider. Select carefully.

If you are a public institution, you will need to satisfy the Law on Public Procurement by tendering the study. Make sure to define the task description well, so you are sure of what is being offered.

Halifax Consulting

Halifax Consulting conducts feasibility studies designed to satisfy banks and other credit institutions. We provide documentation that gives a solid indication of your project’s realism, manageability, sustainability and profitability.

In Serbia and Montenegro, we have made such studies for the European Agency for Reconstruction, for the requirements of the World Bank and other leading institutional lenders. All of the projects we have studied under our EAR-financed programme have received grant funding support. These are major municipal infrastructure projects, valued at 4 – 15 million Euro.

We have contacts to major foreign and domestic banks, who value our studies and who can provide further input to ensure an optimal outcome.

The Halifax team consists of technical, environmental and financial experts, specially selected for the project in question. Their work is combined through intense cooperation to provide an integrated study that meets your specific requirements.