Clearly identify and explain the non-financial (qualitative) factors an organisation

must consider as part of any project economic evaluation, their importance and the
potential consequences of ignoring such issues.
Critically evaluate the financial (quantitative) and non-financial (qualitative) models
and techniques available to appraise investment projects, taking into account risk and
other wider non-financial issues.

Module Name: Project Economics and Evaluation C11PV

Module Coordinator: Dr. Esinath Ndiweni
Submitted by: H00139431
Degree Program: MSc. Strategic Project Management

Total Word Count (Excluding Bibliography) - 2685

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Table of Contents Page No.
Introduction 3

Objective 3

Non-Financial Factors of Project Appraisal 3-5

Financial Models of Project Appraisal 5-7

Non-Financial Models of Project Appraisal 7

Assessing Risk 7

Conclusion 8

References and Bibliography 9-10

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1) Introduction
The ultimate aim of an organisation is to increase the shareholders wealth and this is the sole reason, why
companies undertake those projects that give the best return on the investments made. So it is necessary to
take into account all those financial techniques that collectively with several other non-financial techniques
help an organisation to undertake projects that are most worth and accordingly make decision to invest in them
(Gilbert, 2005).
Across the decades many eminent authors have put prominence to the fact that while assessing the capital
budgeting decisions of a firm, it is equally important to nurture the non-financial aspects also as the decision
making process encompasses both the financial and non-financial analyses (Chen, 1995; Mohamed and
McCowan, 2001; Love et al., 2002). Apart from the quantifiable objectives, there can be certain peripheral
factors that might not appear to be relevant but latter definitely influences the project. Several uncertainties
like natural calamities, the legal obligations, the environmental conditions, the cultural impacts, etc. can
influence the project. Even though the monetary aspects of the project might be very sound, these qualitative
traits need to be explored in detail for the complete sustainability of the project (Moutinho and Lopes, 2010).
Therefore there has been a need to develop a proper appraisal technique that can enable organisations judge
projects reliably with minimum loss and so it can be said that Project Appraisal is not an exact science.

2) Objective
The objective of this essay is to critically evaluate the different non-financial factors an organisation must
consider while accepting a project. Then the essay discusses some critical financial models and techniques of
appraisal and continues to discuss some qualitative models along with a brief on risk assessment.

3) Non-Financial Factors of Project Appraisal

Though a lot of stress has been given on assessing the project in terns of financial viability, but there should
not be a dependence on only the financial factors. The organisation should carefully analyze the non-financial
appraisal techniques to judge the feasibility of the project. Several factors such as the organizational strategy,
political, legal, social, environmental, cultural, organizational and managerial, human resource etc. needs to
be considered for a successful project appraisal.
As the scope of this essay is limited, the discussion would be mainly restricted to some of the most important
factors like the organizational strategy, environmental and locational impact, legal issues and cultural
impacts (Dayananda, et. al, 2002).
Organizational Strategy
Firms generally accept those projects that can contribute to the strategic objectives of them. For long-term
projects, profit maximization is not the sole objective of the firms; rather they focus on diminishing their
weakness, while short-term projects mainly focus on the profit (Kenny, 2003). Long-term projects aim to get

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market share mainly and dont consider the short-term benefits. They are capable of taking more risks in case
of the complex project and use all the resources at their disposal to achieve their objectives. Undertaking risk
is much more relevant to the long-term projects and the bigger firms. The firms should have a clear
understanding of the goals of the organization, should define priorities and analyze its capabilities before
accepting a project inline with their main organizational strategies. However, it should be kept in mind that if
an organization takes a project that has a lower synergy with the organizational strategy, then the degree of
risk would have to be reduced by having a clear cohesive foresight of the possible risks and its mitigation.
Environmental and locational factors
The environmental and the locational factors of a project can never be undermined during its appraisal. The
purpose of this analysis is to understand the damages caused by the project to the nature or environment as
well as to understand the ravages caused by the nature on the project that would impact the success of it (Lopes
and Flavell, 1998). It is also necessary to analyze the factors particularly when the project is huge. On the other
hand, the locational consideration is also a critical project success criterion. The example of Euro Disneyland,
the subsidiary of the famous United States theme park owned by Walt Disney Company can be considered for
the above analyses. Though Disney had undertaken an extensive research before opening up operations in
Europe, they failed to undertake some critical project success factors.
Disney scrutinized above 200 locations in Europe before finally setting the outskirts of East Paris as its Euro
Disney location as Paris was one of the most important tourist destinations of Europe and that the French
government was boosting up infrastructure and approach to the theme park. Disney was however advised by
the French not to open in East Paris that the Disney management ignored. Adding to it was the environmental
effects. Paris was much colder (more than 6 months cold season) than American cities of Florida and California
so had only seasonal vacationers that affected the financial figures of the company. Moreover a lot of additional
spending was incurred for marketing and other promotional offers during the off-season. So an organisation
can never neglect the environmental and locational factors during assuming a project. A way of addressing
this risk is to choose such a location and environment that is of less volatile to an organisation and it is also
important to have a consultative approach with the management and members in the host country about the
possible environmental sways.
Legal Factors
For businesses operating at a global level, it is also essential to understand the different legal issues and laws
of the countries in which they are operating. An important factor to apprehend is the different labour laws
while working overseas. In Euro Disneyland, the French were unable to comprehend the flexibility provided
by US labour laws and thought that it discouraged their work force and lots of legal disputes arose. Labour
cost rose to a massive 40% from an estimated 13%. Also with all the consultations with the French, a lot of
lawyers were used which was a harsh approach according to France where seeking lawyers was the penultimate
approach (Yanaga and Paino, 2003).

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Cultural Factors
It is also an important point to consider the impact of culture on the projects as it plays one of the most if not
the most important qualitative techniques to appraise a project. In the above example of Euro Disneyland,
cultural clash by far played a critical role in the initial project problems. Serving alcohol in the Disney Park
was prohibited according to Walt Disneys policy, but in the French culture, alcohol is considered a part of
daily beverage. Disney also failed to consider the fact that Europeans wanted a good breakfast and had very
little arrangements for a sumptuous breakfast spread. They were also oblivious of the fact that Europeans
wanted lunch and dinner at particular times unlike Americans who would take carry away and eat whenever
necessary. There were thus a lot of flaws and Walt Disneys attempts at Americanizing the European habits
proved costly for them resulting in a low turnout and resentment of the Disney Park in France. However,
gradually Disney understood the cultural imbalances and gradually rectified themselves and also adjusted the
organizational hierarchy by promoting French-origin Phillipe Bourguignon to the top management rather than
a US expatriate who could better deal with the local cultural sensitivities (Yue, 2009).

4) Financial Models of Project Appraisal

There are several financial models of project appraisal. However, studies done by Graham and Harvey (2002)
and Moutinho and Lopez (2010) suggests that analysis using Accounting Rate of Return (ARR), Payback
Period (PBP), Net Present Value (NPV) and Internal Rate of Return (IRR) are some of the most important
models of financial project appraisal. A survey of 1000 large Portuguese firms confirm that 31.7% of the firms
consider ARR, 65.9% of the firms consider PBP as the most important fiscal technique, while NPV accounts
for 68.3% and IRR for 74.4% of the organisations (Graham and Harvey, 2002; Moutinho and Lopez, 2010).
The above mentioned methods are however some of the most recognized decision making tools available to
the current projects. The methods can be classified into two groups: - i) Non-Discounting Cash Flow Method
(NDCF) comprising PBP and ARR and ii) Discounting Cash Flow Method (DCF) comprising NPV and
IRR.
i) Non- Discounting Cash Flow (NDCF)
Every capital project requires some amount of initial investment. Payback Period can be calculated to arrive
at a decision on whether to invest in the particular project or not and acts as a condition of project acceptance
or rejection (Remer and Nieto, 1995). The main advantage of using this method is that its very easy to
understand and gives a quick assessment on the security of the investment. However, the main disadvantage
is that long-term projects cannot be evaluated properly through Payback, as it does not consider the time value
of money while analyzing the cash flows (Afonso and Cunha, 2009).
The Accounting Rate of Return (ARR) is a comparative ratio between the anticipated average profit of a
project and the average accounting value of the investment. The figures used in calculating ARR can be
obtained from the accounting report and so its quite simple to understand and apply. However, like PBP, it

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also does not take into account time value for money and it is based on the accounting figures rather than the
actual project cash flows (Brealey and Mayers; Akalu, 2001).
ii) Discounting Cash Flow Method (DCF)
Some of the most accepted capital budgeting methods are the NPV and the IRR that falls under the DCF
method. These are some of the globally accepted methods of ranking capital investment projects. These are
also some of the most sophisticated methods as they take into account time value of money, future cash flows
and the different risks that may arise in due course of the project. However, there has been a constant argument
on which is the best DCF technique. Nevertheless, theorists debate the flexibility of the NPV usage while
evaluating many aspects (Dixit and Pindyk, 1995; Copeland and Antikarov, 2001).
iii) DCF Vs. NDCF
Correia (2010) in an article on the survey of the different capital budgeting practices of over 500 South African
firms from 1972 to 2008 states the importance of IRR over NPV. The article also says that the bigger firms
use DCF methods mostly as against the smaller companies. However, there has been a tremendous growth in
NPV as compared to IRR, as the results show that NPV practice has increased from 14% in 1972 to 82% in
2006 while, IRR usage has amplified from 64% in 1972 to 79% in 2006. There has been a gradual decreasing
trend of NDCF techniques and the growth of NPV and IRR over the years. A competing contrast with the UK
firms during the same time suggests the growth of NPV from 32% in 1975 to 99% in 2003, while IRR has
pegged a growth from 44% to 89% during the tenure. The survey also showed the growth of DCF techniques
as the most primary technique in most of the advanced and growing economies (Correia, 2010).
Another study done by Hermes et al (2007) among 250 Dutch and 300 Chinese firms suggests the greater use
of NPV among Dutch companies than the Chinese ones. The Chinese firms on the other hand uses ARR
method more than the Dutch firms. However, the organisations of both the countries however notably used
IRR methods (Hermes et al, 2007).
So it can be seen from all the above studies that there is no such fixed financial evaluation methodologies for
the projects, and both DCF and NDCF methods are used in different countries and different firms, however,
the current trend being the use of DCF methods.

5) Non-Financial Models of Project Appraisal

Non-financial factors also play an important role in evaluating project appraisal. As discussed above there can
be several influences of the different qualitative factors on the appraisal apart from the financial assessment.
Several models can be identified that helps in the qualitative evaluation. Dey (2004) in his article has said that
Analytic Hierarchy Process (AHP) helps in the evaluation of environmental and social issues that are being
faced by many projects. This AHP is a multiple-attribute decision-making technique(Dey, 2004, pp. 588).

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To substantiate his claim he has showed a case study on a cross-country petroleum pipeline project of India.
Off-road transportation of the petroleum products through the pipelines is most cost-effective and eco-friendly
friendly means of conveyance, though there can be risks of accidents or interruptions associated with it that
can result in disasters. Thus there is a mandatory socio-economic and environmental assessment before
accepting a project.
In the AHP initially potential projects are screened via Brainstorming or Delphi technique and then a project
analysis team is formed who identifies the project stakeholders. The team along with the stakeholders then
ascertains a feasibility report after careful consideration of the projects influence on the environmental and
social factors. The report is then sent to the Ministry of Environment and Forest for further assessment and
consent. As cited in Deys work by many noted theorists like Mian and Christian (1999), Korpela and
Tuominen (1996), etc., the AHP has been used in evaluating many private sector projects, power and energy
sectors and in risk handling in many other petroleum projects in India and Thailand. The AHP can be
successfully used to address and mitigate operational level risks as it involves various stakeholders (Dey,
2004).
In many cases a judgmental style needs to be adopted by the management of an organisation to study the
strategic benefits of a capital project. The Strategic Index Method or SI method is particularly used in this
regard. In this method, the top management team comes up first with a consensus on the key strategic benefits
of the project. Then an investment appraisal team consisting of important functional managers and a team
facilitator uses a nominal group technique to arrive at a specific key strategic benefit. Then by using a Delphi
method, the team facilitator uses a weighted average approach to reach a consensus on the key benefit. It thus
helps the organisation to seek a project that drives the key business strategy of the organisation. By using the
SI method, a project can be judged from a wide angle and its benefits could be clearly understood which
otherwise would be difficult to judge merely on financial figures (Lefley, 2004).

6) Assessing Risk
Business is all about taking risks. Though there can be numerous methods of assessing project risk it is very
critical to account for the attitude of the project managers that could be used to mitigate risks No two managers
would use the same technique for judging the same risk and it is completely dependent on his personal
assertiveness and experiences. Although different sophisticated financial factors like Discounted NPV, etc.
has been introduced to identify risks, but generally the trend is towards the use of simpler less complicated PB
methods (Lefley, 1997). A project cannot function without risks and managers should know how to reduce the
risk factor and make investment decisions that would be of ultimate benefits to the organisation.

7) Conclusion

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Although, the ultimate aim of any business organisation is to increase revenue, but the path to revenue is not
always obtained with ease as desired by an organisation. Lot of diversities may creep up along the life cycle
of a project that the organisation has undertaken and sometimes the firm has to assume certain losses due to
all these uncertainties. Thus an organisation should always have a mixed portfolio of projects ranging from
high risk to medium and low, so that it can balance out its collection. Instead of judging a project always in
terms of its financial viability, efforts must be taken to approach projects with a holistic approach to judge or
make provisions for all the future non-financial (qualitative) risks that may creep up during the life cycle of
the projects. So, a company would be in the best position to accept a project if it can clearly amalgamate the
quantitative and the qualitative aspects of it.

References and Bibliography

Afonso, P. and Cunha, J. (2009), Determinants of the use of capital investment appraisal methods: Evidences
from the Field, RCAAP, EBSCOhost, [accessed: 5th March 2013]

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Akalu, M. (2001),Re-examining project appraisal and control: developing a focus on wealth creation,
International Journal of Project Management, Vol. 19(1), pp. 375-383

Brealey, R. and Myers, S. (1998), Principles of Corporate Finance, 5th Edition, McGraw-Hill

Chen, S. (1995), An Empirical Examination of Capital Budgeting Techniques: Impact of Investment Types
and Firm Characteristics, The Engineering Economist, Vol. 24(5), pp. 453-470

Copeland, T. and Antikarov, V. (2001), Real Options: a practitioners guide, New York, Texere LLC

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Dayananda, D., Irons, R., Harrison, S., Herbohn, J. and Rowland, P. (2002), Capital Budgeting: Financial
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Dey, P.K. (2004), Analytic hierarchy process helps evaluate project in Indian pipelines industry,
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Dixit, A.K. and Pindyk, R.S. (1995), The options approach to capital investment, Harvard Business Review,
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Gilbert, E. (2005), Capital budgeting: A case study analysis of the role of formal evaluation techniques in the
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Graham, J. and Harvey, C. (2002), How Do CFOs Make Capital Budgeting and Capital Structure Decisions?,
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Hermes, N., Smid, P. and Yao, L. (2007), Capital budgeting practices: A comparative study of the Netherlands
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Lefley, F. (1997), Approaches to risk and uncertainty in the appraisal of new technology capital projects,
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Remer, D. and Nieto, A. (1995), A compendium and comparison of 25 project evaluation techniques. Part 2:
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91

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