Investment Project Design

Size: px

Start display at page:

Download "Investment Project Design"

Pierce Patrick
5 years ago
Views:

1 Investment Project Design

2 Founded in 1807, John Wiley & Sons is the oldest independent publishing company in the United States. With offices in North America, Europe, Australia and Asia, Wiley is globally committed to developing and marketing print and electronic products and services for our customers professional and personal knowledge and understanding. The Wiley Finance series contains books written specifically for finance and investment professionals as well as sophisticated individual investors and their financial advisors. Book topics range from portfolio management to e-commerce, risk management, financial engineering, valuation and financial instrument analysis, as well as much more. For a list of available titles, visit our Web site at

3 Investment Project Design A Guide to Financial and Economic Analysis with Constraints LECH KUROWSKI DAVID SUSSMAN John Wiley & Sons, Inc.

4 Copyright C 2011 by Lech Kurowski and David Sussman. All rights reserved. Published by John Wiley & Sons, Inc., Hoboken, New Jersey. Published simultaneously in Canada. No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise, except as permitted under Section 107 or 108 of the 1976 United States Copyright Act, without either the prior written permission of the Publisher, or authorization through payment of the appropriate per-copy fee to the Copyright Clearance Center, Inc., 222 Rosewood Drive, Danvers, MA 01923, (978) , fax (978) , or on the Web at Requests to the Publisher for permission should be addressed to the Permissions Department, John Wiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030, (201) , fax (201) , or online at Limit of Liability/Disclaimer of Warranty: While the publisher and author have used their best efforts in preparing this book, they make no representations or warranties with respect to the accuracy or completeness of the contents of this book and specifically disclaim any implied warranties of merchantability or fitness for a particular purpose. No warranty may be created or extended by sales representatives or written sales materials. The advice and strategies contained herein may not be suitable for your situation. You should consult with a professional where appropriate. Neither the publisher nor author shall be liable for any loss of profit or any other commercial damages, including but not limited to special, incidental, consequential, or other damages. For general information on our other products and services or for technical support, please contact our Customer Care Department within the United States at (800) , outside the United States at (317) or fax (317) Wiley also publishes its books in a variety of electronic formats. Some content that appears in print may not be available in electronic books. For more information about Wiley products, visit our web site at See the web site for additional information. Library of Congress Cataloging-in-Publication Data: Kurowski, Lech. Investment project design : a guide to financial and economic analysis with constraints/ Lech Kurowski, David Sussman. p. cm. (Wiley finance series) Includes bibliographical references and index. ISBN (cloth) 1. Capital investments Evaluation. 2. Investment analysis. 3. Industrial development projects Finance. 4. Infrastructure (Economics) Finance. 5. Project management Finance. I. Sussman, David (David Louis) II. Title. HG4028.C4K dc Printed in the United States of America

5 To Zosia Kurowska and Claire Sussman for their lifetimes of support

6 Contents Acknowledgments Symbols and Most Frequently Used Acronyms xi xiii Introduction 1 CHAPTER 1 Investment Environment 9 Systematic Project Analysis 10 Project Environment and Strategy 11 Project Development Process 33 Planning Horizon and Project Life 43 Project Scope 44 Preinvestment Studies 46 Investment Planning Infrastructure 58 Appendix 1.1: Elements of Commercial and Wider Domains 60 Appendix 1.2: Outline of Business Plan for a Manufacturing Enterprise 62 Appendix 1.3: Outline of Design/Study Report 63 Appendix 1.4: Information Flow Details 67 Notes 69 References 74 CHAPTER 2 Preparing Pro-Forma Financial Statements 75 Accounting System 77 Process of Financial Analysis 81 Financial Costs and Benefits 84 Investment Costs 87 Production Cost 116 Operating Cost, Factory Cost, and Cost of Product Sold 122 vii

7 viii CONTENTS Financial Statements 127 Appendix 2.1: Depreciation Methods 142 Appendix 2.2: Starting Inventory Balance 148 Notes 150 CHAPTER 3 Financial Indicators and Criteria 155 Static Indicators 155 Types of Static Indicators 156 Dynamic Indicators 169 Financial Criteria for Investment Decisions 188 Analysis of Joint Ventures 203 Project of an Ongoing Enterprise 206 Appendix 3.1: Example of Cost of Capital Calculations 219 Notes 225 References 228 CHAPTER 4 Financing the Project 231 Capital Structure 232 Cost of Capital 249 Notes 255 References 256 CHAPTER 5 The Economic Perspective 257 Private Sector 259 Public Sector 259 General Rationale for Economic Evaluation Who Needs It? 260 Macroeconomic View Impact on the National Economy 262 Price Distortions 266 Applicability and Scope 272 Economic Pricing Principles 278 Shadow Prices of Primary Resources (National Parameters) 292 Conversion and Adjustment Factors 297 Appendix 5.1: Costs and Benefits of Revenue Projects 299

8 Contents ix Appendix 5.2: Global Pricing Framework Importable Input Forgone 301 Notes 303 References 307 CHAPTER 6 Economic Cost/Benefit Analysis 309 Adjustments for the Wider Domain 311 Valuation at Market Prices 311 Define the Accounting Unit 317 Value-Added 343 Notes 354 References 358 CHAPTER 7 Investment Decisions under Uncertainty and Risk 359 Forecasting 359 Risk Dealing with Uncertainty 364 Quantitative Risk Assessment 369 Qualitative Risk Assessment 380 Risk Management 380 Risk Immunization for Financiers 383 International Investors and Risk 385 Appendix 7.1: Discrete Probability Analysis Multivariate 386 Notes 387 References 390 CHAPTER 8 Project Appraisal 391 Macro-Micro Appraisal 392 SWOT Analysis 393 Stakeholder Perspectives 396 Appraisal Report 399 Caveats for the Appraiser 406 Notes 407 References 408 CHAPTER 9 Implementation Planning and Budgeting 409 Implementation Planning 410 Project Management 412

9 x CONTENTS Conducting the Implementation Project 416 Implementation Budget 437 Appendix 9.1: Sample Responsibility Matrix for a Portion of a Project 438 Appendix 9.2: Checklist of Project Implementation Costs 438 Notes 442 References 443 About the Authors 445 Index 447

10 Acknowledgments The foundation for our approach to project design and appraisal consists of ideas and concepts developed from our own work over the course of the past 25 years, and interactions with fellow consultants and others with whom we have collaborated, who graciously shared their knowledge and experiences through informal discussions and communications and formal presentations, and who have added immeasurably to the scope and depth of our effort. Their knowledge and experience in their respective areas of expertise has fused with that of the authors, so it is possible to identify only approximately the areas of contribution of each of the following individuals, to whom we are deeply indebted (listed in alphabetical order): Jadranko Bendekovic, the economic viewpoint, particularly the valueadded approach; Janusz Lukasik, forecasting and the basic idea for the expansion project case study; Andrzej Mlotkowski, project planning, implementation, and contracting; Joseph Moongananiyil who coordinated the work of the staff of the Enterprise Development Institute in Ahmedabad, India, with whom the authors communicated on a wide variety of topics; Klaus Pertz, financial analysis; Reino Routamo, concepts of futuristic forecasting and the basic idea for the yarns case study; Maria Elena Scaffo, market analysis and finance; Aleksander Sulejewicz, who contributed widely to the chapter on economic analysis; Robert Youker, who greatly influenced the presentation on project implementation and management; and Allan Young, project finance, financial planning, and risk. Jerzy Kurowski is responsible for much of the preparation of graphical materials. Michael Lisk, production editor at Wiley, was instrumental in integrating, organizing, and adding to the coherence of the manuscript. Although this edition owes much of its usefulness to contributions of the aforementioned individuals, the authors are solely responsible for any errors and omissions. xi

11 Symbols and Most Frequently Used Acronyms The symbols described below are consistent with international usage. They are, however, used in different contexts and consequently might have slightly different meanings in the main text. The exact meaning is indicated by the subscript for example, i (disc) and i (infl) indicate the discount rate and the inflation rate, respectively, whereas i alone is used to mean interest rate. Financial Symbols BEP breakeven point COPS cost of products sold COT coefficient of turnover (working capital) df discount factor, expressed as percentage EBITDA earnings before interest, taxes, depreciation and amortization F fixed cost (total) f fixed cost of production, subscript denotes related resource FC factory costs FV future value i rate (interest, profit expectations, inflation), expressed as percentage I investment IN inventory IRR internal rate of return j used as subscript; depending on context, describes year number, product number, input number, and so on MIRR modified internal rate of return (expressed as percentage) n number of periods, products, and so on NCF net cash flow NPV net present value P production p market price (product, input, etc.) PC production costs PV present value xiii

12 xiv SYMBOLS AND MOST FREQUENTLY USED ACRONYMS Q, q quantity, unit quantity (e.g., consumption of resource per unit of production) R project revenues (sales) ResV residual value RoI, RoE return on investment, return on equity T tax rate (corporate, income) (expressed as percentage) V value v unit variable cost WACC weighted average cost of capital (expressed as percentage) WCap working capital WiP work-in-progress weight of factor j w j Economic Symbols ADJ adjustment value (difference between adjusted value and original value) AF adjustment factor (expressed as percentage) AU accounting unit AV j values adjusted for distortions of factor j C c market cost of capital CF conversion factor (expressed as percentage) CIF cost, insurance, and freight CRI consumption rate of interest EDR economic discount rate EIRR economic internal rate of return (expressed as percentage) FE foreign exchange FOB free on board FX foreign exchange GDP (GNP) gross domestic (national) product I investment (or capital consumption when indicated) M imports MI material inputs MPS marginal propensity to save MV market value NFIA net factor income from abroad NNI net national income OER official exchange rate RP repatriated payments SCF standard conversion factor (in some methodologies, equal to OER/SER)

13 Symbols and Most Frequently Used Acronyms xv SER shadow exchange rate SP j shadow price (for factor j) SWR shadow wage rate VA value added VDR value with distortions removed VEF value at efficiency priced W wages and salaries WTP willingness to pay X exports

HIGH- FREQUENCY TRADING

A Practical Guide to Algorithmic Strategies and Trading Systems HIGH- FREQUENCY TRADING Irene Aldridge High-Frequency Trading A Practical Guide to Algorithmic Strategies and Trading Systems IRENE ALDRIDGE