HOW TO WRITE A COMPREHENSIVE FEASIBILITY STUDY...

Hello readers,
Do you have a great idea for a new product? Perhaps your homemade apple jam or orange juice or something which is famous among your friends and family and you've been thinking about turning your hobby into a business, but aren't sure that there's enough demand in your area to make the project worth your time and effort , or you aren't sure how to begin your research.
In all of these cases, you would benefit from performing a feasibility study. Put simply, a feasibility study is a process during which you test an idea's viability: will it work? Although the specific questions you will have to address will vary depending upon the nature of your project or idea, there are some basic steps that apply to all feasibility studies. Read on to learn about the basic but comprehensive steps after the cut...

1.    THE NEEDS ANALYSIS

The needs analysis gives definition to the proposed project, preparing the way for the solution options analysis in Stage 2, which explores the range of possible solutions to meeting the identified needs.

The needs analysis will have been considered during the Infrastructure Planning Stage. During this feasibility study phase it will be thoroughly interrogated and where necessary amended to reflect the

Part 1: Demonstrate that the project aligns with the institution’s strategic objectives

Part 2: Identify and analyse the available budget(s)

Part 3: Demonstrate the institution’s commitment and capacity

Part 4: Specify the outputs

Part 5: Define the scope of the project

Part 1: Demonstrate that the project aligns with the institution’s strategic objectives

To be in an institution’s best interests, a project needs to align with the institution’s policy and priorities.

Step 1: Summarise the institution’s mission and vision statements, its strategic objectives, and the government policy that determines what the institution’s deliverables are.

Step 2: Describe the functions that the institution performs in the public interest or on behalf of the public service.

Step 3: Discuss the following aspects of the project:

·         How does the project contribute to the implementation of government and institutional policy?

·         Does the institution have the ability and the capacity to provide the services?

·         What is the relative size of the project, in terms of its anticipated budget or capital expenditure?

·         What are the potential cost savings for the institution?

·         How complex is the project?

·         What does the public require in relation to the services?

·         Given the proposed duration of the project, will it address the broad needs of the institution over time?

·         Will the proposed project meet the institution’s needs in the time required?

Part 2: Identify and analyse the available budget(s)

This analysis must include:

·         A discussion of any assumptions about future budgetary commitments required from government: How much will be required over what period of time, escalating by the CPIX?

·         A discussion of any consolidation of budgets, namely drawing funds from various budgets into a consolidated budget which will be ring-fenced for this project. These budgets may be internal to the institution but may also involve identification of budgets in other institutions, for example the Department of Public Works.

·         A list of the line items currently in the institution’s budget for costs which may no longer be incurred as a result of the proposed project. For example: If a government department is housed in different buildings, there may be costs associated with delivering mail between buildings. If the proposed project is to house the department in one building, the department would no longer incur these costs, which then represent potential savings.

Refer to the relevant treasury’s directives on budget preparation in terms of the PFMA.

Part 3: Demonstrate the institution’s commitment and capacity

It needs to be clear that the institution can manage, process, evaluate, negotiate and implement the project.

Step 1: Provide an assessment of

·         lines of decision-making within the institution, particularly between project officer, senior management and the accounting officer/authority

·         any areas where a lack of capacity exists, in the project team or in the transaction advisor

·         a plan on how the lack of capacity will be addressed throughout the project process

·         the plans for skills transfer from the transaction advisor to the project team at various stages of the project

·         how staff turnover will be managed.

Step 2: Provide information on key stakeholders

1. Possible key stakeholders include:

·         those within the institution

·         other government departments

·         other spheres of government

·         organised labour

·         third parties

·         the public.

2. Describe the nature of each relationship and the project’s impact on each stakeholder

In particular, identify impacts on the funding, resources or processes of the key stakeholders. This is important for establishing where the service will begin and end. For example in IT related components, the State Information Technology Agency (SITA) could be a key stakeholder and this would help to define where the IT services would begin and end.

3. Include a consultation plan

The plan should detail how and when consultation will take place during the project preparation period of the project cycle and how the views and contributions of key stakeholders will be incorporated into the project. Also include the results of any consultation the institution has already undertaken, and any required concurrence obtained from government stakeholders, such as permission from South African Heritage Resources Agency (SAHRA) to demolish a building.

Step 3: Consult with the relevant treasury

Consult with the relevant treasury about the project, especially about budgetary and affordability issues.

For national departments and public entities this will entail discussions with the Public Finance division of National Treasury and with the institutions’ own accounting officers and chief financial officers.

For provincial departments and public entities, there must be consultation with the Intergovernmental Relations division of National Treasury and the provincial treasury.

Part 4: Specify the outputs

Once the institution’s objectives and budget have been identified, and its commitment and capacity demonstrated, the outputs of the proposed project need to be specified.

Step 1: Describe the service that the institution needs to deliver

Step 2 Specify the outputs required to deliver that service

Step 3: Specify the minimum standards for the outputs

This will ensure that the service delivered by the project meets the institution’s expectations.

Step 4: Assess whether the output specifications can meet the institution’s ongoing service needs

It may be necessary to specify to what extent the project must provide a flexible solution that can be expanded or enhanced over time.

Step 5: Specify key indicators that will measure performance

This will allow for more accurate costing of the output specifications.

Step 6: Identify service interface expectations

This concerns the interface between the project and the institution’s other services.

Step 7: List the BEE and socio-economic targets that the institution wishes to achieve in the project.

Part 5: Define the scope of the project

In light of the institution’s needs and strategic objectives, and the output specifications for delivering the required service, give a brief definition of the proposed scope of the project. This should be a concise outline of the institution’s requirements, which will allow for the selection of reasonable service delivery options.

Briefly set out:

• a summary of how the project objectives will address the institution’s strategic objectives, as determined in Part 1
• a summary of the output specifications, as determined in Part 4
• a list of significant government assets which will be used for the project (such as land and equipment)

2.    THE OPTIONS ANALYSIS

Step 1: List all the solution options the institution has considered

The list must cover the range of the most viable solution options for providing the specified outputs of the required service.

Step 2: Evaluate each solution option

The purpose of the evaluation is to:

• identify the advantages and disadvantages of each solution option
• examine the risks and benefits for, and potential impacts on, government of each option

Use the following template to set out each option

Brief description

Briefly describe each solution option, including an outline of the alignment between each option and the institution’s strategic plan, the service it needs to deliver, and the output specifications.

Financial impacts

For each option show the estimated initial capital expenditure, and the likely capital and operational costs over the full project cycle. (This preliminary analysis of financial impacts will provide a basis for the detailed work to come later in the feasibility study.)

Funding and affordability

How is each option to be funded? Which options are affordable?

Risk

Present a preliminary discussion about the risks to government in relation to each option.

BEE and other socio-economic aspects

Provide a preliminary view on the impact of each option on the BEE targets set out in the outputs specifications, and other socio-economic targets on which the institution may wish to deliver in the project.

Service delivery arrangements

Discuss the service delivery arrangements for each option, and analyse the implications of each option for optimal interface between services. For example, if the institution is assessing its options for accommodation services, how would each solution option deal with the integration of IT and communications services?

Transitional management issues

Discuss the issues that may arise in the transition from existing management arrangements in each solution option. For example, each solution option for staff accommodation will have implications for how a department’s security, IT, delivery and despatch systems are managed in the transition from the existing to the new.

Technical analysis

A comprehensive technical analysis must be presented for each solution option, including a supply chain/interface analysis. Include an assessment of the proposed technology and its appropriateness for each solution option.

Site issues

If a solution option involves a physical site, issues around the procurement of land must be identified at this stage, such as: land use rights, zoning rights, geo-technical, environmental issues, relevant national or provincial heritage legislation, and alignment with municipal Integrated Development Plans. (These issues will be dealt with in detail in the due diligence stage below, but must be identified for each solution option now.). The preference is for all site issues to be resolved during the feasibility study.

Legislation and regulations

Does a particular option comply with the relevant legislation and regulations? Analyse firstly procurement legislation and regulations, and secondly sector-specific legislation and regulations, which may impact on the project, to establish a compliance list against which each option can be measured.

Human resources

·         Establish the numbers and cost of existing institutional staff that will be affected in each solution option, do a skills and experience audit, and establish the key human resources issues for the project.

·         Design and implement a suitable communication strategy for the institution to keep staff informed of the project investigations, as required by labour law.

·         Assess the following for each option, if relevant:

- organised labour agreements

- the cost of transferring staff, if applicable

- an actuarial study of accrued benefits that may be transferred

- an initial view on the potential willingness of both staff and private parties to implement transfers.

Qualitative factors

There will be a number of qualitative benefits associated with a particular option, which may not be quantifiable and may not be considered as offsetting costs.  It is important that these qualitative factors be identified early. For example: Cabinet has agreed that all departmental head offices must be located in the inner city. So although there might be a suitable building or site outside of the inner city, which may be cheaper or more appropriate for other reasons, Cabinet’s decision will affect the choice of solution option.

 

Step 3: Choose the best solution option

Each solution option has now been be evaluated. A matrix approach can be used to weight up the evaluation of each option against another to assist in the choice of the best one.

Category	Option 1	Option 2	Option 3
Brief description
Application of Criteria
Construction Cost	45 000 000	42 000 000	58 000 000
Operations Cost	1 500 000 per annum	1 500 000 per annum	2 000 000 per annum
Funding and Affordability	Sufficient	Sufficient	Insufficient capital funds
Risk Rating	Low	Medium	Medium –
Role for BEE	Low	Low/Medium	Low/Medium
Service Delivery Arrangements	Low – very difficult to move large contract	Medium	Medium
Transitional Management Issues	Low	Low	Low
Technical Analysis Suitability Innovation etc	Low	Medium	Medium
Site Issues Impact	Low	Medium	Medium
Legislation and Regulation Issues	Low	Low	Nil
Impact on HR	High	Low	Nil
Qualitative Assessment	Good outcomes	Medium	Medium
Score	25	20	5
OPTION RATING	1	2	3

In this last step of the solution options analysis stage, recommend which option(s) should be pursued to the next stage.

It is preferable that only one solution option is chosen, and no more than three. If more than one option is recommended, each must be separately assessed in the financial analysis stage below.

3.    PROJECT DUE DILIGENCE

The due diligence stage is an extension of the solution options analysis stage and aims to uncover any issues in the preferred solution option that may significantly impact on the proposed project.

Step 1: Legal issues

Although a preliminary legal analysis of each solution option was done in the options analysis stage, a comprehensive legal due diligence of the preferred option(s) must now be done to ensure that all foreseeable legal requirements are met for the development of the project. Although it may be costly to undertake a comprehensive legal due diligence of all aspects of the project in this early phase, it is ultimately worthwhile. Early legal certainty directly affects project costing in Stage 4 (thus assisting in making the procurement choice).

Common legal issues that arise are around use rights and regulatory matters. However, the institution’s legal advisors should conduct a thorough due diligence on all the legal issues which have a bearing on the project.

If the project being explored is a greenfields project and the institution has never done this kind of project before, then a regulatory due diligence will be required.

Investigate any regulatory matters that may impact on the Institution’s ability to deliver as expected. These may include:

• tax legislation
• labour legislation
• environmental and heritage legislation
• sector regulations such as airport licensing, health standards, building codes, etc.

Step 2: Site enablement issues

If the institution nominates a particular site, it will need to identify, compile and verify all related approvals. The purpose is to uncover any problems that may impact on the project’s affordability or cause regulatory delays at implementation.

Establish the following:

·         land ownership

·         land availability and any title deed endorsements

·         Are there any land claims?

·         Are there any lease interests in the land?

Appoint experts to undertake surveys of:

·         environmental matters

·         geo-technical matters

·         heritage matters

·         zoning rights and town planning requirements

·         municipal Integrated Development Plans.

Step 3: BEE and other socio-economic issues

Identify sectoral BEE conditions (for example, the extent to which BEE charters have been developed and implemented), black enterprise strength in the sector, and any factors that may constrain the achievement of the project’s intended BEE outputs. Also identify socio-economic factors in the project location that will need to be directly addressed in the project design.

4.    FINANCIAL ASSESSMENT

Part 1: Construct the project cost model

The project cost model represents the full costs to the institution of delivering the required service according to the specified outputs via the preferred solution option using conventional public sector procurement.

The project cost model costing includes all capital and operating costs associated with the project and also includes a costing for all the risks associated with project.

The public sector does not usually cost these risks, but it is necessary to get this understanding of the full costs to government of the proposed project.

Key characteristics of the project cost model

·         Expressed as the net present value (NPV) of a projected cash flow based on an appropriate discount rate for the public sector

·         Based on the costs for the most recent, similar, public sector project, or a best estimate

·         Costs expressed as nominal costs

·         Depreciation not included, as it is a cash-flow model.

Example of a Project Cost Model

Base PROJECT FINANCIAL MODEL: Nominal cash flow (R thousands)
	Year
	0	1	2	3	4	5	6	7	8	9	10	11		12
DIRECT COSTS
Capital costs
Land costs	5,000
Design and construction contract price	15,000	55,650	39,326	17,865
Payments to consultants	3,333	3,533	3,745
Plant and equipment	5,000	15,900	33,708
Capital upgrade						20,073
Life-cycle capital expenditure						17,665			21,039			25,058
Maintenance costs				4,764	5,050	5,353	5,674	6,015	6,375	6,758	7,163	7,593		8,049
Operating costs
Wages and salaries				5,955	6,312	6,691	7,093	7,518	7,969	8,447	8,954	9,491		10,061
Running costs				2,382	2,525	2,676	2,837	3,007	3,188	3,379	3,582	3,797		4,024
Management costs				1,191	1,262	1,338	1,419	1,504	1,594	1,689	1,791	1,898		2,012
INDIRECT COSTS
Construction overhead costs	1,000	1,060	1,124
Operating overhead costs				238	252	268	284	301	319	338	358	380		402
Administrative overhead costs				596	631	669	709	752	797	845	895	949		1,006
LESS
Third-party revenue				5,955	6,312	6,691	7,093	7,518	7,969	8,447	8,954	9,491		10,061
Subtotal: Base PROJECT FINANCIAL MODEL	29,333	76,143	77,903	27,036	9,721	48,042	10,923	11,578	33,311	13,009	13,790	39,674		15,494
Discount factor: 10%	1.0	0.91	0.83	0.75	0.68	0.62	0.56	0.51	0.47	0.42	0.39	0.35		0.32
Discounted cash flow	29,333	69,221	64,383	20,313	6,640	29,830	6,166	5,941	15,540	5,517	5,316	13,906		4,937
NPV of base PROJECT FINANCIAL MODEL	277,043

The central functions of the project cost model

·         promotes full cost pricing at an early stage

·         is a key management tool during the procurement process, assisting the institution to stay focused on the output specifications, costs and risk allocation

·         is a reliable way of demonstrating the project’s affordability

·         is a consistent benchmark and evaluation tool during procurement

 

Step 1: Provide a technical definition of the project

What norms and standards will be applied in the project? What maintenance cycles are expected?

Step 2: Calculate direct costs

Direct costs are those that can be allocated to a particular service. These costs must be based on the most recent public sector project to deliver similar infrastructure or services (including any foreseeable efficiencies, for example regular life-cycle maintenance), or a best estimate where there is no recent comparable public sector project. If there are no comparable projects in South Africa, draw on the experience of projects in similar environments in other countries.

1. Capital costs

Direct capital costs are specifically associated with the delivery of new services, including, but not limited to, the costs of design, land and development, raw materials, construction, and plant and equipment (including IT infrastructure). Direct capital costs should also account for the projects’ labour, management and training costs, including financial, legal, procurement, technical and project management services. It is also important to include the costs of replacing assets over time.

2. Maintenance costs

Direct maintenance costs will include the costs over the full project cycle of maintaining the assets in the condition required to deliver the specified outputs, and may include the costs of raw materials, tools and equipment, and labour associated with maintenance. The level of maintenance assumed must be consistent with the capital costs and the operating cost forecasts.

3. Operating costs

Direct operating costs are associated with the daily functioning of the service and will include full costs of staff (including wages and salaries, employee benefits, accruing pension liabilities, contributions to insurance, training and development, annual leave, travel and any expected redundancy costs), raw materials and consumables, direct management and insurance.

Step 3: Identify indirect costs

The project’s indirect costs are a portion of the institution’s overhead costs, and will include the costs of: senior management’s time and effort, personnel, accounting, billing, legal services, rent, communications and other institutional resources used by the project. The portion can be determined by using an appropriate method of allocation, including but not limited to:

·         number of project employees to total institutional employees for personnel costs

·         project costs to total institutional costs for accounting costs

·         number of project customers to total institutional customers for billing costs.

Step 4: Identify any revenue

The total cost of delivering the service should be offset by any revenues that may be collected.

Project revenue may be generated where:

·         users pay for the service or a part thereof

·         the use of the institution’s assets generates revenue

·         service capacity exists above the institution’s requirement

·         the institution allows third parties to use the service.

Any revenue collected must reflect the institution’s ability to invoice and collect revenue. (This should have been identified during Stage 2.)

Step 5: Explain assumptions

Explain in detail all assumptions the model makes about the inflation rate, the discount rate, depreciation, treatment of assets, available budget(s), and the government’s Medium-Term Expenditure Framework (MTEF).

Inflation

The model should be developed using nominal values. In other words, all costs should be expressed with the effects of expected future inflation included. Nominal figures reflect the true nature of costs, as not all costs are inflated at the same rates. This also allows for easy comparison with the institution’s budget, which is expressed using nominal values. Inflation projections should be made with reference to the inflation targets set by the Reserve Bank. The MTEF budget cycle which government uses is adjusted annually by CPIX.

The discount rate

For practical purposes the discount rate is assumed to be the same as the risk-adjusted cost of capital to government.

Depreciation

Since the PROJECT FINANCIAL MODEL is calculated on cash flow, not on accrual, non-cash items such as depreciation should not be included.

Part 2: Construct the risk-adjusted PROJECT FINANCIAL MODEL

Part 2 Calculate the project Risk and include in the project cost model

In conventional public sector procurement, risk is the potential for additional costs above the project cost model. Historically, conventional public sector procurement has tended not to take risk into account adequately. Budgets for major procurement projects have been prone to optimism bias – a tendency to budget for the best possible (often lowest cost) outcome rather than the most likely. This has led to frequent cost overruns. Optimism bias has also meant that inaccurate prices have been used to assess options. Using biased price information early in the budget process can result in real economic costs resulting from an inefficient allocation of resources.

Much of the public sector does not use commercial insurers, nor does it self-insure (through a captive insurance company). Commercial insurance would not provide value for money for government, because the size and range of its business is so large that it does not need to spread its risk, and the value of claims is unlikely to exceed its premium payments. However, government still bears the costs arising from uninsured risks and there are many examples of projects where the public sector has been poor at managing insurable (but uninsured) risk.

Step 1: Identify the risks

Explore each risk category in detail. It is important to identify and evaluate all material risks. Even if a risk is unquantifiable, it should be included in the list. Do not forget to include any sub-risks that may be associated with achieving the BEE targets set for the project.

When identifying risks by referring to an established list, there is the possibility that in the list generated for the project, a risk not listed may have been left out by mistake (as opposed to simply not being a risk for this specific project).

It may be difficult to compile a comprehensive and accurate list of all the types of risks. The following can be helpful sources of information:

• similar projects (information can be gathered from the original bid documents, risk matrices, audits and project evaluation reports) both in South Africa and internationally
• specialist advisors  with particular expertise in particular sectors or disciplines.

Step 2: Identify the impacts of each risk

The impacts of a risk may be influenced by:

• Effect: If a risk occurs, its effect on the project may result, for example, in an increase in costs, a reduction in revenues, or in a delay, which in turn may also have cost implications. The severity of the effect of the risk also plays a role in the financial impact.
• Timing: Different risks may affect the project at different times in the life of the project. For example construction risk will generally affect the project in the early stages. The effect of inflation must also be borne in mind.

It is essential to specify all the direct impacts for each category of risk. For example, construction risk is a broad risk category, but there could be four direct impacts, or sub-risks:

• cost of raw material is higher than assumed
• cost of labour is higher than assumed
• delay in construction results in increased construction costs
• delay in construction results in increased costs as an interim solution needs to be found while construction is not complete.

Each impact is thus a sub-risk, with its own cost and timing implications.

Step 3: Estimate the likelihood of the risks occurring

Estimating probabilities is not an exact science, and assumptions have to be made. Ensure that assumptions are reasonable and fully documented, as they may be open to being challenged in the procurement process or be subject to an audit. There are some risks whose probability is low, but the risk cannot be dismissed as negligible because the impact will be high (for example the collapse of a bridge). In this case a small change in the assumed probability can have a major effect on the expected value of the risks. If there is doubt about making meaningful estimates of probability, it is best practice to itemise the risk using a subjective estimate of probability rather than to ignore it. Institutions should also be prepared to revisit initial estimates, if they learn something new that affects the initial estimate. Together with estimating the probability of a risk occurring, it is also necessary to estimate whether the probability is likely to change over the term of the project.

Step 4: Estimate the cost of each risk

Estimate the cost of each sub-risk individually by multiplying the cost and the likelihood.

Assess the timing of each sub-risk.

Cost the sub-risk for each period of the project term.

Construct a nominal cash flow for each risk to arrive at its net present value.

Example of nominal cash flow for each risk

Risk	Year
	0	1	2	3	4	5	6	7	8	9	10	11	12
Design and construction risk
Cost overrun		3,061	7,570	8,024	3,645
Time overrun			1,613	3,763	3,763	1,613
Similar service provision			825	1,925	1,925	1,925
Upgrade cost			8,652
Operating risk				1,498	1,588	1,684	1,785	1,892	2,005	2,126	2,253	2,388	2,532
Performance risk				1,787	1,894	2,007	2,128	2,255	2,391	2,534	2,686	2,847	3,018
Maintenance risk
General maintenance risk				581	616	653	692	734	778	824	874	926	982
Patient area maintenance risk				484	513	543	576	610	647	686	727	771	817
Technology risk				1,251	1,326	1,405	1,182	1,253	1,328	1,408	1,492	1,582	1,677
Subtotal: Risk	-	3,061	18,659	19,312	15,269	9,830	6,363	6,744	7,149	7,578	8,033	8,515	9,026
Discount factor: 10%	1.0	0.91	0.83	0.75	0.68	0.62	0.56	0.51	0.47	0.42	0.39	0.35	0.32
Discounted cash flow	-	2,783	15,421	14,510	10,429	6,104	3,592	3,461	3,335	3,214	3,097	2,984	2,876
Present value of risk	71,805

Step 5: Identify strategies for mitigating the risks

A risk can be mitigated either by changing the circumstance under which the risk can occur or by providing insurance for it. Indicate what the risk mitigation strategy for dealing with each particular risk will be, and the attendant cost of such mitigation.  This is the most important part of the risk assessment and should identify specific steps taken or to be taken to mitigate risks.

Example of Risk Analysis and Mitigation Table

Risk	Description	Consequence	Risk value (R thousand)	Mitigation
1. Design and construction risk	The risk that the construction of the physical assets is not completed on time, budget or to specification.	Cost & delay	43,200
1.1 Cost overruns	1.1.1 Increase in the construction costs assumed in base PROJECT FINANCIAL MODEL model.	Cost	19,250
1.2 Time overruns	1.2.1 Increase in the construction costs assumed in base PROJECT FINANCIAL model as a result of delay in the construction schedule	Delay resulting in additional cost	10,750
	1.2.2 Cost of interim solution. Results in additional cost of maintaining existing building or providing a temporary solution due to inability to deliver new facility as planned.	Cost of interim solution	5,500
1.3 Upgrade costs	1.3.1 Increase in construction costs if the planned facility is not sufficient and additional capacity needs to be added.	Cost of upgrades	7,700
2. Operating risk	The risk that required inputs cost more than anticipated; are inadequate quality or are unavailable.	Cost increases and may impact on quality of service. Cost p.a.	1,258
3. Performance risk	Risk that services may not be delivered to specification	Service unavailability. Inability of Institution to deliver public service. Alternate arrangements may need to be made to ensure service delivery, with additional costs. Cost p.a.	1,500
4. Maintenance risk	Risk that design/ construction is inadequate and results in higher than anticipated maintenance costs. Higher maintenance costs generally.	Cost increases. May impact on Institution's ability to deliver public services.	894
4.1 General maintenance risk	Risk that design/ construction is inadequate and results in higher than anticipated maintenance costs in general area. Higher maintenance costs generally.	Cost increases. May impact on Institution's ability to deliver public services. Cost p.a.	488
4.2 Patient area maintenance risk	Risk of higher than anticipated maintenance costs in patient area for which Institution is responsible.	Cost increases. May impact on Institution's ability to deliver public services. Cost p.a.	406
5. Technology risk	Risk that technical inputs may fail to deliver required output specs or technological improvements may render the technology inputs in the project out-of-date.	Cost increases.	10,500

Step 6: Construct the risk-adjusted project cost model

Once costs have been established for all identified risks, the base project cost model must be risk-adjusted. This is done using the following simple formula:

Risk-adjusted cost = Base cost + Risk

Example of Risk Adjusted Project Financial Model

	Year
	0	1	2	3	4	5	6	7	8	9	10	11	12
Direct capital costs	28,333	75,083	76,779	17,865	-	37,738	-	-	21,039	-	-	25,058	-
Direct maintenance costs				4,764	5,050	5,353	5,674	6,015	6,375	6,758	7,163	7,593	8,049
Direct operating costs	-	-	-	9,528	10,100	10,706	11,348	12,029	12,751	13,516	14,327	15,186	16,098
Indirect costs	1,000	1,060	1,124	834	884	937	993	1,053	1,116	1,183	1,254	1,329	1,409
Less: Third-party revenue	-	-	-	5,955	6,312	6,691	7,093	7,518	7,969	8,447	8,954	9,491	10,061
Subtotal: Base PROJECT FINANCIAL MODEL	29,333	76,143	77,903	27,036	9,721	48,042	10,923	11,578	33,311	13,009	13,790	39,674	15,494
Risk value	-	3,061	18,659	19,312	15,269	9,830	6,363	6,744	7,149	7,578	8,033	8,515	9,026
Total cash flows	29,333	79,204	96,562	46,348	24,990	57,872	17,285	18,322	40,461	20,587	21,822	48,189	24,520
Discount rate: 10%	1.0	0.91	0.83	0.75	0.68	0.62	0.56	0.51	0.47	0.42	0.39	0.35	0.32
Discounted cash flows	29,333	72,004	79,804	34,822	17,069	35,934	9,757	9,402	18,875	8,731	8,413	16,890	7,813
Present value of risk-adjusted PROJECT FINANCIAL MODEL	R348,847

Step 7: Preliminary analysis to test affordability

As a preliminary assessment of the project’s affordability, compare the risk-adjusted project cost model with the institution’s budget for the project as estimated during the solution options analysis.  If the project looks unaffordable by a wide margin, it may be necessary to revisit the options analysis.

5.    SENSITIVITY ANALYSIS

A sensitivity analysis determines the resilience of the base project cost model to changes in the assumptions that the model has been based on.

The institution and its advisors should test the sensitivity of key variables to test their impact on affordability, and risk, such as:

·         inflation rate

·         discount rate

·         construction costs

·         total operating costs

·         BEE costs

·         service demand

·         third-party revenue, if any

For example, an increase in the assumed capital cost may lower an associated risk. This will allow the institution to view the potential spread of the total cost to government.

6.    DEMONSTRATE AFFORDABILITY

The budget for the project has been identified at various stages prior to this. At this stage, it must be scrutinised in detail and confirmed in order to demonstrate project affordability.

Step 1: Determine the institutional budget available for the project

Institutions should refer to the National Medium-Term Expenditure Estimates (NMTEE) and their own detailed budgets. Include all the applicable available amounts, namely direct and indirect costs, and any third-party revenues. Where necessary, include budgetary allocations that would be available to the project from other institutional budgets (such as capital works allocations on the Public Works vote).

7.    VERIFY INFORMATION AND SIGN-OFF

Step 1: Verify the information used in the feasibility study

Constructing the project cost  models and developing the risk costing are information-intensive exercises. The conclusions which will be drawn from the models are highly dependent on the quality and accuracy of the information they are based on. Because the models will need to be referred to throughout the procurement phase, it is necessary to provide the following information, as an annexure to the feasibility study:

• A statement from the institution and its advisors on the reasonableness of the information collected, assumptions made and costings carried out. All advisors and technical consultants should sign off on their design and costings as professionals using their best endeavours.  For complex projects or projects where there is little precedent, it is strongly recommended that an independent party checks that the assumptions are reasonable and confirms that they have been correctly incorporated into the model to produce an accurate result (arithmetic and logic). This may have cost and time implications.
• A record of the methodologies used for valuing various costs, including the costs of key risks.
• A statement on how an audit trail of all documentation has been established and maintained to date, and how it will be managed throughout the project. This is an essential requirement, especially for the purposes of the Auditor-General and in terms of the Promotion of Access to Information Act, 2000.

Step 2: Draw up a checklist for legal compliance

Legal advisors must draw up a checklist for legal compliance. (This may be a summary of work undertaken during Stage 3.

Step 3: Sign off the feasibility study

All inputs into the feasibility study must be signed off as accurate and verifiable by each of the transaction advisor specialists.

8.    ECONOMIC VALUATION

An economic valuation is warranted in:

• greenfield projects
• capital projects of significant capital spend (say R100 Million)
• projects that warrant an analysis of externalities (such as major rail, port, airport projects).

NOTE : The National Treasury is of the opinion that on social sector projects the assumptions of intangible externalities such as health, time, welfare, and education outcomes and so on make economic appraisals secondary to through needs analyses and strategic planning.  In addition much of the benefits of such appraisals, for example risk identification, will be achieved by following the methodology used in this toolkit.

Where used, a range of well-known micro-economic techniques exists for undertaking an economic valuation, requiring the analysis to:

• Give a clear economic rationale for the project.
• Identify and quantify the economic consequences of all financial flows and other impacts of the project.
• Detail the calculation or shadow prices/opportunity costs for all inputs and outputs, including:

- foreign exchange

- marginal cost of public funds

- opportunity cost of public funds (discount rate)

- high, medium and low skill labour

- tradable and non-tradable inputs

- tradable and non-tradable outputs (including consumer surplus, where relevant, based on financial or other model quantities).

• Identify an appropriate ‘no-project’ scenario and calculate the associated economic flows, treating them as opportunity costs to the project.
• Identify the economic benefits to BEE, and the opportunity costs to BEE of a ‘no-project’ scenario.
• Provide a breakdown of the economic costs and benefits of the project into its financial costs and benefits and various externalities.
• Do a detailed stakeholder analysis, including the project entity, private sector entity, government, and others.

9.    PROCUREMENT AND IMPLEMENTATION PLAN

A procurement and implementation plan must contain at least the following:

• a project timetable for the key milestones and all approvals which will be required to take the project to completion
• confirmation that sufficient funds in the institution’s budget are available to take the project to completion

• the best procurement practice and procedures suited to the project type and structure and that meet the requirements of equity, transparency, competitiveness and cost effectiveness
• the governance processes to be used by the institution in its management of the procurement, especially regarding decision-making
• the project team with assigned functions
• a list of required approvals from within and outside the institution

• a GANTT chart of the procurement process, including all approvals and work items necessary for obtaining these approvals (for procurement documentation as well as, for example, the land acquisitions and environmental studies to be procured by the institution)
• contingency plans for dealing with deviations from the timetable and budgets
• an appropriate quality assurance process for procurement documentation
• the means of establishing and maintaining an appropriate audit trail for the procurement
• appropriate security and confidentiality systems, including confidentiality agreements, anti-corruption mechanisms, and conflict of interest forms to be signed by all project team members.

The feasibility study report must provide as much information as is necessary for the relevant treasury to assess the merits of the project.

Submit as much information as possible, making use of annexures, which have been referenced in the appropriate section of the main part of the report. All documents that have informed the feasibility study and are of decision-making relevance to the project must be part of the feasibility study report.

The report must not refer to any document that has not been submitted as part of the report

10.  REVISITING THE FEASIBILITY STUDY

The feasibility study must become the reference point for the Institution during procurement.  When any assumptions change the feasibility study must be changed to see what impact the change will have PRIOR TO IMPLEMENTING THE CHANGE

References www.wikihow.com