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PENGANTAR

Studi Kelayakan dan Ekonomi Teknik


Dr. Andri IRFAN Rifai
Doktor Teknik Transportasi Universitas Indonesia Universidade do Minho Portugal

Dosen Tetap Teknik Sipil Universitas Internasional Batam

Dosen Luar Biasa Teknik Sipil Universitas Mercubuana Jakarta; Ukrida Jakarta; UnMa

Staff Ditjen Bina Marga, Kementerian Pekerjaan Umum dan Perumahan Rakyat

0816 766 707

andrirfan@yahoo.com

Data mining; pavement maintenance; geometric; project management in highway; public


policy in infrastructure
FEASIBILITY STUDY
THE FEASIBILITY STUDY:
SOMETHING WE ALREADY KNOW
Feasibility study as project plan - assumes the
project concept is feasible and maps out the
course for project implementation
Focus on engineering aspects low attention to
social, institutional, environmental aspects
Economic and/or financial analysis limited to
budgeting exercise and some cash flow
Feasibility analysis as part of the process is
missing
THE FEASIBILITY STUDY:
INTERNATIONAL STANDARDS
Feasibility study is the result of feasibility analysis
Convince the reader (financing entity) that the project is
worth funding
Document relevant information and aspects regarding the
project
Assess whether the project is relevant, viable and
implementable
Enable the project proponent to prepare financing
application and present the project to sources of
financing
PROJECT PREPARATION VIS--VIS
PROJECT CYCLE
Strategic and Sectoral Considerations

Project Pre-feasibility
Project Study, PPD
Sustainability Identification

Project Project
Execution Preparation
Feasibility
Study, EIA,
PSD
Feedback
loops
Implementation
Project Start-up
Planning
Process flow PIP
OVERVIEW OF FS CONTENTS AND OUTLINE
Executive Summary (PSD)

I. Introduction

II. Project Strategic Context

III. Technical Analysis

IV. Institutional Assessment

FEASIBILITY V. Environmental Assessment


STUDY VI. Stakeholder Analysis

VII. Financial and Socio-Economic Analysis

VIII. Conclusions

IX. Project Implementation Plan

IX. Appendices
Project Strategic Context

Strategic goals; priority programs at


local/regional level
National policies: National, regional or sectoral
goals which the project supports
Project environment issues: policy, legal and
regulatory, institutional framework, environmental,
etc.
Technical Assessment
Several subsequent assessment levels:
Technical assessment of existing services, physical
system, and treatment, and measures for their
optimum use
Demand (market analysis) analysis and forecasting
Establish gap between the current level service and
future demand
Develop technical alternatives for the project
required outputs (design, technology, process,
scale)
Technical Assessment - Illustration for scope
of wastewater project
Wastewater services:
Determine service area and coverage
Identify consumers per categories
Develop scenarios for future service development
Wastewater system:
Description of existing system and facilities
Evaluate the system components and its operation
Wastewater treatment:
Describe and assess existing facilities
Describe and assess present environmental impacts
of untreated wastewater/sludge discharges into
surface water bodies
Financial and Socio-economic Rationale of
environmental investment project
Purpose of the financial analysis is multiple:
Assessment of project viability and implement
ability for the municipal utility and the local
community and economy
A tool for analyzing, structuring and selecting
different project options
Assessment of project returns on overall investment
and capital
A tool for identifying appropriate types of project
financing
Analysis of project broader socio-economic impact
to the community
ASPECTS OF FEASIBILITY ANALYSIS
INPUT TO THE FINANCIAL AND SOCIO-ECONOMIC ANALYSIS

Technical
Analysis
Financial Social and
Analysis Stakeholder
Analysis
Project Feasibility

Economic Environmental
Analysis Analysis

Institutional Analysis
Financial Cost-Benefit Analysis of a Project

q The unit of analysis is the project, not the


company
q Evaluates and calculates the projects financial:
Revenues
Costs
Net benefits (of revenues over the costs)
q Project revenues, costs and net benefits are
determined on a with-project and without project
basis.
Financial Cost-Benefit Analysis
Project Revenues
q Only the project contributed revenues, i.e.
water/wastewater sales to the utility are estimated:
q The project revenues are determined for different
groups of users (different tariffs):
Households
Government/public institutions
Commercial/industrial users
Other (connection fees)
Financial Cost-Benefit Analysis
Project Costs
1. Investment costs:
q Capital costs: land, civil works, equipment, studies
q Education programs, lab equipment & training,
q Institutional Development (consulting services,
capacity building programs, M&E of benefits)
2. Operation and maintenance costs: labor, electricity,
chemicals, materials, overheads, raw water
charges, insurance, etc.
3. Residual values (of project assets at the end of the
project life)
Conclusions of the Financial Analysis
Selection of options and technology
Overall project profitability and
sustainability
Financial impact on the utility
Final phasing of investments and priorities
Financing Plan and application requirements
Tariff setting and proposal to the
municipality
Responsibility chart
Project cash flow skeleton for conducting
socio-economic analysis
Economic Cost-Benefit Analysis of a Project

Purpose: To assess the project economic worth to


the country
Evaluates and calculates the projects economic
benefits and costs to the whole economy in constant
economy prices (adjusted financial prices) including
external benefits:
Environmental benefits
Health effects
Non-technical losses (UFW)
SOCIAL AND STAKEHOLDER ANALYSIS
Local Government q Ultimately all ventures are
about people!
Consumers q Its more important to

Operator/Utility understand the people than


the technology: Who
Vulnerable groups gains? Who loses?
q Social and distribution
Wider community
analysis of project effects
Financier (different beneficiaries)
q Poverty Impact Analysis
Environmental Impact Analysis
Assessment of project impacts to physical and also non-
physical environmental aspects:
Physical (water, air, land)
Biodiversity
Nuances (noise, odors)
Safety
Aesthetics, cultural and historical heritage
Two possible levels of assessment:
Preliminary (Initial) Environmental Review
Full Environmental Impact Assessment
Institutional Analysis

Assessment of legal and institutional framework


Relationship and independence of the water company
from the municipality in setting tariffs
Capacity of the project entity to: implement, manage
and maintain the project
Financial sustainability of the project entity
Adequate project management processes, including
procurement and human resources
Capacity building programs
Sensitivity and Risk Analysis
A technique for investigating the impact of changes in
project variables
Identify key variables which influence project costs and
benefits
Investigate the consequences of likely adverse changes
Identify mitigation actions
Qualitative Risk Analysis at the: project level, sector
level and national level
SUMMARY-1
The feasibility analysis is an internationally
accepted process used to evaluate various
project dimensions important for achieving the
desired project benefits.
An effective tool for appraising the project from
standpoints of all project stakeholders
It is not a waste of time. It significantly reduces
the risks in project implementation
ENGINEERING ECONOMIC CONCEPT
LEARNING OUTCOMES
1) Role in decision making

2012 by McGraw-Hill, New York, N.Y All Rights Reserved


2) Study approach
3) Ethics and economics
4) Interest rate
5) Terms and symbols
6) Cash flows
7) Economic equivalence
8) Simple and compound interest
9) Minimum attractive rate of return
10) Spreadsheet functions
WHY ENGINEERING ECONOMY IS
IMPORTANT TO ENGINEERS

2012 by McGraw-Hill, New York, N.Y All Rights Reserved


Engineers design and create
Designing involves economic decisions
Engineers must be able to incorporate economic
analysis into their creative efforts
Often engineers must select and implement from
multiple alternatives
Understanding and applying time value of money,
economic equivalence, and cost estimation are
vital for engineers
A proper economic analysis for selection and
execution is a fundamental task of engineering
TIME VALUE OF MONEY (TVM)
Description: TVM explains the change in the amount

2012 by McGraw-Hill, New York, N.Y All Rights Reserved


of money over time for funds owed by or owned by a
corporation (or individual)
Corporate investments are expected to earn a return
Investment involves money
Money has a time value

The time value of money is the most important concept in


engineering economy

1-26
ENGINEERING ECONOMY
Engineering Economy involves

2012 by McGraw-Hill, New York, N.Y All Rights Reserved


Formulating
Estimating, and
Evaluating
expected economic outcomes of alternatives designed to
accomplish a defined purpose

Easy-to-use math techniques simplify the evaluation


Estimates of economic outcomes can be deterministic
or stochastic in nature
GENERAL STEPS FOR DECISION MAKING
PROCESSES

2012 by McGraw-Hill, New York, N.Y All Rights Reserved


1. Understand the problem define objectives
2. Collect relevant information
3. Define the set of feasible alternatives
4. Identify the criteria for decision making
5. Evaluate the alternatives and apply sensitivity analysis
6. Select the best alternative
7. Implement the alternative and monitor results
STEPS IN AN ENGINEERING ECONOMY STUDY

2012 by McGraw-Hill, New York, N.Y All Rights Reserved


ETHICS DIFFERENT LEVELS

2012 by McGraw-Hill, New York, N.Y All Rights Reserved


Universal morals or ethics Fundamental beliefs:
stealing, lying, harming or murdering another are wrong
Personal morals or ethics Beliefs that an individual has
and maintains over time; how a universal moral is
interpreted and used by each person
Professional or engineering ethics Formal standard or
code that guides a person in work activities and decision
making
CODE OF ETHICS FOR ENGINEERS

2012 by McGraw-Hill, New York, N.Y All Rights Reserved


All disciplines have a formal code of ethics. National Society of
Professional Engineers (NSPE) maintains a code specifically for
engineers; many engineering professional societies have their own code
INTEREST AND INTEREST RATE

2012 by McGraw-Hill, New York, N.Y All Rights Reserved


Interest the manifestation of the time value of
money
Fee that one pays to use someone elses money
Difference between an ending amount of money and a
beginning amount of money

Interest = amount owed now principal

Interest rate Interest paid over a time period


expressed as a percentage of principal


RATE OF RETURN
Interest earned over a period of time is expressed as
a percentage of the original amount (principal)

2012 by McGraw-Hill, New York, N.Y All Rights Reserved


interest accrued per time unit
Rate of return (%) = x 100%
original amount

Borrowers perspective interest rate paid


Lenders or investors perspective rate of return earned
INTEREST PAID INTEREST EARNED

2012 by McGraw-Hill, New York, N.Y All Rights Reserved


Interest rate Rate of return
COMMONLY USED SYMBOLS
t = time, usually in periods such as years or months

2012 by McGraw-Hill, New York, N.Y All Rights Reserved


P = value or amount of money at a time t;
designated as present or time 0
F = value or amount of money at some future
time, such as at t = n periods in the future
A = series of consecutive, equal, end-of-period
amounts of money
n = number of interest periods; years, months
i = interest rate or rate of return per time period;
percent per year or month
CASH FLOWS: TERMS

2012 by McGraw-Hill, New York, N.Y All Rights Reserved


q Cash Inflows Revenues (R), receipts, incomes, savings
generated by projects and activities that flow in. Plus sign used
q Cash Outflows Disbursements (D), costs, expenses, taxes
caused by projects and activities that flow out. Minus sign used

q Net Cash Flow (NCF) for each time period:

NCF = cash inflows cash outflows = R D

q End-of-period assumption:
Funds flow at the end of a given interest period
CASH FLOWS: ESTIMATING
Point estimate A single-value estimate of a cash flow

2012 by McGraw-Hill, New York, N.Y All Rights Reserved


element of an alternative
Cash inflow: Income = $150,000 per month

Range estimate Min and max values that estimate the


cash flow
Cash outflow: Cost is between $2.5 M and $3.2 M

Point estimates are commonly used; however, range estimates with


probabilities attached provide a better understanding of variability
of economic parameters used to make decisions
CASH FLOW DIAGRAMS
What a typical cash flow diagram might look like

2012 by McGraw-Hill, New York, N.Y All Rights Reserved


Draw a time line Always assume end-of-period cash flows

Time
0 1 2 n-1 n
One time
period
F = $100

Show the cash flows (to approximate scale)

0 1 2 n-1 n
Cash flows are shown as directed arrows: + (up) for inflow
P = $-80
- (down) for outflow
CASH FLOW DIAGRAM EXAMPLE

2012 by McGraw-Hill, New York, N.Y All Rights Reserved


Plot observed cash flows over last 8 years and estimated sale next
year for $150. Show present worth (P) arrow at present time, t = 0
ECONOMIC EQUIVALENCE

2012 by McGraw-Hill, New York, N.Y All Rights Reserved


Definition: Combination of interest rate (rate of return)
and time value of money to determine different
amounts of money at different points in time that are
economically equivalent

How it works: Use rate i and time t in upcoming relations


to move money (values of P, F and A) between time
points t = 0, 1, , n to make them equivalent (not equal)
at the rate i
EXAMPLE OF EQUIVALENCE

2012 by McGraw-Hill, New York, N.Y All Rights Reserved


Different sums of money at different times may be equal in
economic value at a given rate $110

Year

0 1
Rate of return = 10% per year

$100 now
$100 now is economically equivalent to $110 one year from now,
if the $100 is invested at a rate of 10% per year.
SIMPLE AND COMPOUND INTEREST
Simple Interest

2012 by McGraw-Hill, New York, N.Y All Rights Reserved


Interest is calculated using principal only
Interest = (principal)(number of periods)(interest rate)
I = (P) (n) (i) or =Pni

Example:
$100,000 lent for 3 years at simple i = 10% per year. What is
repayment after 3 years?

Interest = 100,000(3)(0.10) = $30,000

Total due = 100,000 + 30,000 = $130,000

1-42
SIMPLE AND COMPOUND INTEREST
Compound Interest

2012 by McGraw-Hill, New York, N.Y All Rights Reserved


Interest is based on principal plus all accrued interest
That is, interest compounds over time

Interest = (principal + all accrued interest) (interest rate)

Interest for time period t is


COMPOUND INTEREST EXAMPLE
Example:

2012 by McGraw-Hill, New York, N.Y All Rights Reserved


$100,000 lent for 3 years at i = 10% per year compounded. What is repayment
after 3 years?
Interest, year 1: I1 = 100,000(0.10) = $10,000
Total due, year 1: T1 = 100,000 + 10,000 = $110,000

Interest, year 2: I2 = 110,000(0.10) = $11,000


Total due, year 2: T2 = 110,000 + 11,000 = $121,000

Interest, year 3: I3 = 121,000(0.10) = $12,100


Total due, year 3: T3 = 121,000 + 12,100 = $133,100

Compounded: $133,100 Simple: $130,000


MINIMUM ATTRACTIVE RATE OF RETURN

2012 by McGraw-Hill, New York, N.Y All Rights Reserved


MARR is a reasonable rate of return
(percent) established for evaluating
and selecting alternatives
An investment is justified
economically if it is expected to
return at least the MARR
Also termed hurdle rate, benchmark
rate and cutoff rate

1-45
MARR CHARACTERISTICS
MARR is established by the financial managers of the firm

2012 by McGraw-Hill, New York, N.Y All Rights Reserved


MARR is fundamentally connected to the cost of capital
Both types of capital financing are used to determine the
weighted average cost of capital (WACC) and the MARR
MARR usually considers the risk inherent to a project

1-46
TYPES OF FINANCING

2012 by McGraw-Hill, New York, N.Y All Rights Reserved


Equity Financing Funds either from retained earnings,
new stock issues, or owners infusion of money.
Debt Financing Borrowed funds from outside sources
loans, bonds, mortgages, venture capital pools, etc.
Interest is paid to the lender on these funds

For an economically justified project

ROR MARR > WACC

1-47
OPPORTUNITY COST
Definition: Largest rate of return of all projects not

2012 by McGraw-Hill, New York, N.Y All Rights Reserved


accepted (forgone) due to a lack of capital funds
If no MARR is set, the ROR of the first project not undertaken
establishes the opportunity cost

Example: Assume MARR = 10%. Project A, not funded due


to lack of funds, is projected to have RORA = 13%. Project
B has RORB = 15% and is funded because it costs less
than A
Opportunity cost is 13%, i.e., the opportunity to make an
additional 13% is forgone by not funding project A

1-48
INTRODUCTION TO SPREADSHEET FUNCTIONS
Excel financial functions

2012 by McGraw-Hill, New York, N.Y All Rights Reserved


Present Value, P: = PV(i%,n,A,F)
Future Value, F: = FV(i%,n,A,P)
Equal, periodic value, A: = PMT(i%,n,P,F)
Number of periods, n: = NPER((i%,A,P,F)
Compound interest rate, i: = RATE(n,A,P,F)
Compound interest rate, i: = IRR(first_cell:last_cell)
Present value, any series, P: = NPV(i%,second_cell:last_cell) + first_cell

Example: Estimates are P = $5000 n = 5 years i = 5% per year


Find A in $ per year
Function and display: = PMT(5%, 5, 5000) displays A = $1154.87
1-49
INVESTMENT APPRAISAL
AND THEORY OF CONSTRAIN
INVESTMENT APPRAISAL

Source: www.bized.co.uk/educators/16-19/business/accounting/presentation/investment1
INVESTMENT APPRAISAL
A means of assessing whether an investment
project is worthwhile or not
Investment project could be the purchase of a new
PC for a small firm, a new piece of equipment in a
manufacturing plant, a whole new factory, etc
Used in both public and private sector
INVESTMENT APPRAISAL
Types of investment appraisal:
Payback Period
Accounting Rate of Return
(ARR)
Internal Rate of Return
(IRR)
Profitability Index
Net Present Value
(discounted cash flow)

What factors need to be considered before


investing in equipment such as this?
Copyright: Gergely Erno, stock.xchng
INVESTMENT APPRAISAL

Why do companies invest?


Importance of remembering investment as the purchase of
productive capacity NOT buying stocks and shares or
investing in a bank!

Buy equipment/machinery or build new plant to:


Increase capacity (amount that can be produced) which
means:
Demand can be met and this generates sales revenue
Increased efficiency and productivity
INVESTMENT APPRAISAL
Investment therefore
assumes that the investment
will yield future income
streams
Investment appraisal is all
about assessing these
income streams against the
cost of the investment
A fork lift may be an important item
but what does it contribute to overall
sales? How long and how much work Not a precise science!
would it have to do to repay its initial
cost?
Copyright: Loisjune, stock.xchng
PAYBACK PERIOD
PAYBACK METHOD
The length of time taken to repay the initial capital
cost
Requires information on the revenue the investment
generates
e.g. A machine costs 600,000
It produces items that sell at 5 each and produces
60,000 units per year
Payback period will be 2 years
PAYBACK METHOD
Payback could occur during a year
Can take account of this by reducing the cash inflows
from the investment to days, weeks or years
Days/Weeks/Months x Initial Investment

Payback = ------------------------------------------
Total Cash Received
PAYBACK METHOD
e.g.
Cost of machine = 600,000 Income
Annual income streams from
Year 1 255,000
investment = 255,000 per year
Year 2 255,000
Payback = 36 x 600,000/765,000
Year 3 255,000
= 28.23 months
(2 yrs, 6 months)
ACCOUNTING RATE OF RETURN
ACCOUNTING RATE OF RETURN

A comparison of the profit generated by the


investment with the cost of the investment
Average annual return or annual profit

ARR = --------------------------------------------
Initial cost of investment
ACCOUNTING RATE OF RETURN
e.g.
An investment is expected to yield cash flows of 10,000
annually for the next 5 years
The initial cost of the investment is 20,000
Total profit therefore is: 30,000
Annual profit = 30,000 / 5
= 6,000
ARR = 6,000/20,000 x 100
= 30%
A worthwhile return?
INVESTMENT APPRAISAL
To make a more informed
decision, more
sophisticated techniques
need to be used.
Importance of time-value
of money
NET PRESENT VALUE (NPV)
NET PRESENT VALUE
Takes into account the fact that money values
change with time
How much would you need to invest today to earn x
amount in x years time?
Value of money is affected by interest rates
NPV helps to take these factors into consideration
Shows you what your investment would have earned
in an alternative investment regime
NET PRESENT VALUE
e.g.
Project A costs 1,000,000
After 5 years the cash returns = 100,000 (10%)
If you had invested the 1 million into a bank
offering interest at 12% the returns would be greater
You might be better off re-considering your
investment!
NET PRESENT VALUE
The principle:
How much would you have to invest now to earn
100 in one years time if the interest rate was 5%?
The amount invested would need to be: 95.24
Allows comparison of an investment by valuing cash
payments on the project and cash receipts expected
to be earned over the lifetime of the investment at
the same point in time, i.e the present.
NET PRESENT VALUE
Future Value
PV = -----------------
(1 + i)n
Where i = interest rate
n = number of years
The PV of 1 @ 10% in 1 years time is 0.9090
If you invested 0.9090p today and the interest rate
was 10% you would have 1 in a years time
Process referred to as:
Discounting Cash Flow
NET PRESENT VALUE
Cash flow x discount factor = present value
e.g. PV of 500 in 10 years time at a rate of
interest of 4.25% = 500 x .6595373 = 329.77
329.77 is what you would have to invest
today at a rate of interest of 4.25% to earn
500 in 10 years time
PVs can be found through valuation tables
(e.g. Parrys Valuation Tables)
NPV CALCULATION : SINGLE PERIOD CASE

initial cash outflow

cash inflow in one period

present value of next periods cash flow

Source: www.owlnet.rice.edu
NPV CALCULATION :
MULTIPLE PERIODS, ANNUAL COMPOUNDING (CONTINUED)

Present value factor

NPV of a stream of cash flows


NPV CALCULATION :
MULTIPLE PERIODS, WITHIN YEAR COMPOUNDING

Compounding for m periods within the year


r Stated Annual Interest Rate (SAIR)
r
Interest for each of m periods
m

Now m periods Next year

2 m
C r r r
C 1 + C 1 + C 1 +
m m m

FV of an investment C
after T years
Example
Consider an investment of $1,000 that is expected to yield $500 in 1
year and $700 in 2 years. What is the NPV of the investment at an
annual discount rate of 9% ?

What happens if the interest is compounded semi annually?


CASH FLOWS
DISCOUNTED CASH FLOW
An example:
A firm is deciding on investing in an energy efficiency
system. Two possible systems are under investigation
One yields quicker results in terms of energy savings
than the other but the second may be more efficient
later
Which should the firm invest in?
DISCOUNTED CASH FLOW SYSTEM A
Year Cash Flow () Discount Factor Present Value ()
(4.75%) (CF x DF)

0 - 600,000 1.00 -600,000

1 +75,000 0.9546539 71,599.04

2 +100,000 0.9113641 91,136.41

3 +150,000 0.8700374 130,505.61

4 +200,000 0.8305846 166,116.92

5 +210,000 0.7929209 166,513.39

6 +150,000 0.7569650 113,544.75

Total 285,000 NPV =139,416


DISCOUNTED CASH FLOW SYSTEM B
Year Cash Flow () Discount Factor Present Value ()
(4.75%) (CF x DF)
0 - 600,000 1.00 -600,000
1 +25,000 0.9546539 23,866.35
2 +75,000 0.9113641 68,352.31
3 +85,000 0.8700374 73,953.18
4 +100,000 0.8305846 83,058.46
5 +150,000 0.7929209 118,938.10
6 +450,000 0.7569650 340,634.30
Total 285,000 NPV =108,802.70
DISCOUNTED CASH FLOW
System A represents the better investment
System B yields the same return after six years
but the returns of System A occur faster and
are worth more to the firm than returns
occurring in future years even though those
returns are greater
QUESTIONS AND DISCUSSION
WASSALAM

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