Financial Feasibility Study Chapter

This chapter discusses financial aspects of a project, including the project's financial structure, cash flow estimation, cost analysis, financial/economic evaluations, issues of using cost of capital, impact of inflation, and sensitivity analysis.

Financial structure refers to the mix of funding sources used by a project to finance its investments.
It comprises long-term and short-term debt components.

Short-term financing is secured from external sources, with repayment obligations within one year.
Key considerations are the company's reliance on this type of financing and its cost/risk profile.

Trade credit is short-term financing obtained from suppliers, often in the form of deferred payment terms.
Its cost is dependent on supplier's terms - in the absence of discounts, it's effectively interest-free. If discounts are offered, the cost depends on whether the company takes advantage of them.

Example: 10/2 net 30 days; Cost of Financing = 2% x 360 / (30-2) = 36.7%.

Short-term bank loans are lower-cost than trade credit, provided the company can't secure favourable trade terms.
The cost is usually expressed as an interest rate on the loan amount, influenced by applicable tax rates and loan terms between the lender and borrower.

Long-term financing encompasses funds obtained from external sources with repayment periods exceeding one year, primarily used for fixed asset acquisitions.

Common stocks represent ownership with par value, book value, market value, and liquidation value.
Par value is the printed value on the stock certificate.
Book value reflects the value of equity, less preferred shares, divided by the number of outstanding common shares.
Market value is the stock's price in the capital market.
Liquidation value is the expected value received by a shareholder upon liquidation of the company's assets.

Preferred shares represent ownership with a par value (or a stated issuing value) and market value.
Par and book values usually coincide.
Preferred stocks are essentially a hybrid between common stocks and bonds. They often have the right to be redeemed at any time, unlike with common stock, and carry a certain degree of debt-like obligations.

Retained earnings are profits the company reserves from distribution to shareholders for various reasons, including legal compliance (minimum statutory profit retention percentage and mandatory reserve limits), specific business decisions (e.g, reinvestment, debt reduction, and expansion funding), and risk mitigation and/or financial stability.
Cost of retained earnings is equivalent to the cost of common equity, assuming the absence of any issuance fees or tax implications.

Long-term debt is sourced from financial institutions, like banks or insurance companies, and involves negotiations on terms like interest rates, maturity date, and collateral.
Bonds, a form of long-term debt, are sold to various parties.
Bond value is often tied to prevailing market interest rates.

Cost of capital represents the weighted average cost of all capital sources. A high cost of capital may signal increased likelihood of investment project rejection given the low yield relative to the funding costs.

Cash flow encompasses both inflows (receipts) and outflows (payments).
Inflow components include sales, asset disposals, collection of accounts receivable, promissory notes, and other income streams like investments and charitable donations.
Outflow components include purchases of goods, fixed assets, payment of accounts payable, repayment of loans and interest, operational expenses, and dividend distributions.

Cost estimations are carried out for project initiation up to operation, encompassing preliminary and operational costs.
Preliminary costs span land acquisition (at market rates), building/construction, furniture/equipment, and contingencies.
Operational costs encompass raw materials and packaging, labor costs (salaries, benefits, bonuses), maintenance expenses, rentals, permits/licenses, research/development, transportation, insurance, marketing , general utility costs, and various other operational expenses.

Evaluation metrics, which differ in sophistication, range from subjective assessments to objective quantitative methods.
Key criteria include payback period, average rate of return, net present value(NPV), and profitability index.

Sensitivity Analysis evaluates the impact of changes in key variables on the viability of a project, particularly under conditions of uncertainty.
Key variables include sales price, variable costs, fixed costs, project investment costs, and external factors, such as political, environmental or economic conditions(e.g. the impact of government policies on product pricing or consumers' preferences).