FEASIBILITY STUDY, ECONOMIC EVALUATION

AND PRELIMINARY DESIGN

A paper prepared by Eng. Peter Maina Wakori for presentation at the Project
Management Seminar organized by the Institution of Engineers of Kenya
21st to 23rd July 2008

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FEASIBILITY STUDY
Feasibility studies are normally confused with economic studies. The word feasibility is
derived from feasible which means that it is possible and likely for the project to be
achieved. Feasibility studies are supposed to show whether a project is possible and likely
to be achieved under the current and future conditions. Economic studies on the other
hand are supposed to determine the viability of a project. Economic viability of a project
means that is capable of developing and surviving independently in a particular economic
environment. It is however normal to combine the two.
In the cases of the feasibility studies, projects are tested against opportunities and
constraints of a project as well their ability to meet the objectives of the project by
yielding the desired output. Some questions are supposed to be answered by feasibility
studies in case of a road:
• Given the topography and hydrology of the area to be served by the road, is it
feasible to construct the road at the given budget? For example it is required to
improve transportation around Mt. Kenya or Lake Victoria. The shortest
possible route around these of obstacles may require tunneling. Is it feasible
that the tunneling will be achieved at the available budget? If not the alternative
is to construct the road around the lake or the mountain, but the distances may
such that construction of the road is yet again not feasible at the available
budget.
• Given the social, economic or travel patterns (present and future) of the
population of an area, is it feasible the proposed solution will yield the outputs
that meet their objective?
• Given the loading patterns of vehicles expected to use the road, is it feasible
for the proposed alternative to be constructed to the required loading standards
at the proposed budget?
• Is the institution or institutions responsible for the construction, maintenance
and operation of the project prepared adequately in terms of technology,
financial and personnel resources to implement the project as planned?
It is therefore necessary in the case of a feasibility study to establish the current situation
in terms of social, economic and other aspects and predict the future situation with regard
to the same.
Feasibility Study of a Road Project
In carrying out a feasibility study of a road project, the following must be addressed as a
minimum:
• The socio-economic environment in the country
What are the general indicators of the performance of the economy and society?
How are they performing and how are they supposed to perform in future given
the stated goal and objectives of the country? What are the effects of the changes
socio-economic situation on generation and growth of traffic on roads in general
and the project road in particular?

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 • The transport sector in general:
How is it organized? What are the policies of the sector? What are the other
modes of transport that will affect the performance of the road project and how?
How do we address the effects of the other transport modes so that the road project
can perform as desired? For example, the Mombasa-Nairobi railway line, the
oil pipeline and air travel between the two cities have an effect on the level
and loading of traffic on the Mombasa-Nairobi road. Supposing these modes
are allowed to compete without restrictions on any one of them, what would
happen?

• The road sector in particular

How is it organized? What are the policies of the sector? What are its strengths and
weaknesses that will affect the performance of the project? What are the vehicle
licensing, insurance and operating strategies? For example, the overloading by
trucks, if not controlled will limit the effectiveness of a road project to serve a
particular area over the design life.
• The Ministry responsible for roads
What are the road-specific objectives and policies of the Ministry? What size of
the network is it responsible for? How is its performance in construction and
maintenance of the network? What is the trend in performance: improving or
declining? What is the ministry’s technological, financial and personnel capacity
to oversee the construction, operation and maintenance of roads in general and the
project road in particular?
• The road project
Where is it located? The population of the area and the trends in growth. What is
the zone of influence and what are land uses and socio-economic activities of the
area? How is the topography, climate and hydrology of the area of influence?
What are the traffic levels on the road now if it exists and what factors will affect
its generation and growth? Where are the material and water sites? Given all the
issues learned from the state of the economy, the transport sector, the road sector,
the ministry and the road area itself, predict the performance characteristics of the
road.
These are almost the same questions asked in the preliminary design but one proceeds to
design the horizontal and vertical alignments of the road, the drainage structures, road
furniture etc taking into account, the traffic, topographical climatic and hydrological
conditions prevailing in the area traversed. The output of the preliminary design is a
preliminary engineer’s estimate which is an input into the next step.

ECONOMIC EVALUATION
My previous presentation dwelt with four of the five phases of planning. Today, we will
discuss in a little more detail the fourth phase: Evaluation and Choice. This is because
feasibility studies and economic analysis are part of this phase.

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GENERAL
Following the generation and analysis of alternative solutions to a problem, the next
phase of the process involves the evaluation of the alternative solutions. In simple terms,
a project may be viewed as a production process that consumes resources in order to
produce outputs which are of use to the community. The resources consumed for the
construction and operation of a project may be expressed in monetary terms.
The outputs of the project may be thought of as creating both benefits and disbenefits.
Typical changes in transport output which yield benefits are:
• Decrease in travel times between points in an area
• Decrease in vehicle operating costs
• Improvement in travel safety

Examples of transport project outputs which create disbenefits are adverse

environmental impacts such as noise and air pollution.

The essence of investment evaluation is to assemble both the benefits and disbenefits in
order to obtain net benefits that are likely to be produced by the investment, and to
compare the net benefits with the resource costs required.

ECONOMIC EVALUATION

As mentioned earlier, the essence of project evaluation is to compare a stream of

benefits and costs associated with the project.

Estimation of Costs

Costs of projects are classified as capital costs, operation costs and maintenance costs.
Where systems, rather than projects are being evaluated the planner considers all the
three: capital, operation and maintenance costs. However, in the evaluation of projects,
only capital and maintenance costs are considered.

Capital costs are incurred early in the project life while maintenance and operational
costs are incurred soon as construction of a project is completed.

Costs of alternative projects are normally expressed in terms of the market prices of the
resources required for the construction, operation and maintenance of the facility. The
fundamental assumption underlying this approach is that competitive conditions in the
marketplace will ensure that the most efficient combination of input factors will be
used. This assumption is only valid if the prices of the resources used are equal to the
marginal cost of using the resources. The fairly restrictive conditions under which this
assumption holds are described in many planning publications. For example, one
condition is that there is full employment in the economy.

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Shadow pricing of Costs

All project or system costs: capital, operating and maintenance are derived during that
activity called preliminary engineering design.

I therefore feel duty bound to explain certain misconceptions that may be reflected by
the way this seminar is structured. During the duration of this seminar, I am expected to
provide presentations on:

• Project Identification and Procurement of Consultancy services.

• Feasibility Study, Economic Evaluation and Preliminary Design.

Feasibility Study is part of the Evaluation and Choice phase of the planning process.
Economic Evaluation is only one of the methods of evaluation of projects and systems.
And as we have just seen Preliminary Engineering Design is a step that feeds into the
evaluation step: economic or otherwise.

The costs derived at the Preliminary Engineering Design stage are called financial
costs. As we have seen above, one the conditions under which project costs can be
expressed in terms of market prices is that there is full employment in the economy.
Therefore for us to use financial costs in economic evaluation there must be full
employment in the economy. One other condition is that use is being made only of
local resources, financial or otherwise.

Consider the following example: Assume the wage rate for labourers is 15 shillings per
hour. In estimating the cost of a road project, the total input of labour required by the
project would be multiplied by 15 shillings which is the cost of labour to the contractor.
However, the unemployment rate of might be relatively high, requiring welfare systems
to the unemployed of say 5 shillings. The cost to the society of using unemployed
labourers on a road project is clearly not the 15 shillings per hour paid out by the
contractor, but simply the extra, or marginal cost of utilizing the unemployed labourers.

In view of the above and other deviations from the explained conditions, financial costs
are transformed into economic costs using proportions of the various inputs into the
costs. For example:

Economic Capital costs = F (1-0.5x.18) + (0.32 x 0.7)-0.15

Where:
F is financial costs
Contribution of unskilled labour is 50% of 18% of the total construction costs (where it
is assumed that 50% of the unskilled workforce is unemployed and they contribute 18%
of the total wage bill during construction.

Foreign costs contribute 32% of the 70% foreign contribution to the construction costs.
is the proportion of the local to foreign financial contribution.
Taxes are 15% of the construction costs.

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 (Note the fractions and proportions are hypothetical and need to be confirmed
during evaluation)

This step will require one to shadow price capital, operating and maintenance costs
separately because the components of labour, finances and equipment also vary in each
of them. The costs are also to be annualized, that is allocated to each year of project
construction, operation and maintenance.

Estimation of Benefits

Benefits of the project also cannot accrue until the project is completed.
The concept of a demand curve is central to the derivation of the benefits associated
with expenditures on public projects. A demand curve illustrates the way in which the
quantity of good or service consumed varies with unit price of a good or service.

Demand curves are usually assumed to possess a negative slope. That is as the
price increases the less the demand. Demand curves depict the reaction of consumers
to prices for a particular set of incomes and prices for the other goods and services
available to consumers. Changes in income or the prevailing prices for other goods and
services, may change the demand curve. For many goods and services the demand
curve may be determined empirically.

Example of a demand curve pg 306

UNIT PRICE OF GOOD

D1
p1
D

q1

QUANTITY CONSUMED

Fig.A.1 A hypothetical demand curve

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Economic theory attempts to explain the nature of the demand curve in terms of a
theory of consumer behaviour. The utility of an economic good or service may be
defined as the subjective benefit which a consumer receives from the consumption of
the good or service. Consumers only need to state which of two goods is preferred
without attempting to report the absolute magnitude of the strengths of these
preferences.

A consumer is assumed to have a set of preferences and to allocate a limited income in

such a way as to maximize his well being or welfare. A consumer is said to be in
equilibrium when a particular allocation of his income yields a level of welfare that
cannot be exceeded by any other allocation of income.

Consumer behahiour is developed in terms of an indifference curve. Points along the

consumer indifference curve identify a combination of quantities of goods or services
consumed to which the consumer is indifferent.

Example of a consumer indifference curve

Increasing
QUANTITY OF y2 CONSUMED

A D Welfare

c
c
B
0 QUANTITY OF y1 CONSUMED

Fig. a.2 A Consumer indifference curve

The Demand Curve

The slope of an indifference curve at any point shows the rate at which a consumer is
prepared to give up the consumption of one item to increase the consumption of another
while retaining a constant level of welfare. The absolute magnitude of the slope is
called the consumer’s marginal rate of substitution of the goods. It may be regarded as
the consumer’s subjective rate of exchange between goods.

The consumer indifference curve may be used to determine an individual’s demand

curve for a particular good. A demand curve conveys a consumer’s indifference
between the utility of a good or service and money. A demand curve represents the
result of two of forces: the desires of consumers and their willingness to pay to satisfy
these desires. A community demand curve for a good may be derived by summing
up the individual demand curves. The community demand curve will therefore
represent the community’s desires and its willingness to pay to satisfy the desires.

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 OACD = Total community benefit
OBCD = Market value

PRICE PER IUNIT

BAC = Consumers’ surplus
Consumers’ Surplus = Net Community Benefit

B p

Market
Value

Q
O D

AMOUNT CONSUMED

For example, it is the desire of the community is to reduce the accidents by 5 accidents
per month. To quantify the 5 accidents in monetary terms one requires to ask: what
does the community wish to pay to avoid each accident?

One principle is based on insurance the community is willing to pay for cars, other
property and life lost through accidents. The annual benefit will therefore be 5x
insurance premium (for cars + for other property + life).This will be annualized by
multiplying the result by 12 months. Arguments have been raised against the
willingness to pay theory: Do people’s value of life correlate with their willingness to
pay? Do they peg their life insurance premiums against the willingness or ability to
pay?

Typical benefits of a road improvement project include:

• Vehicle operating costs savings.

• Avoided maintenance savings
• Time savings
• Reduction in accident rates
• Reduction in the noise and air pollution.

Estimation of benefits for objectives which can easily be expressed in monetary values
is straightforward. For example, should one option be to improve a road from gravel to
bitumen standards, vehicle operating costs savings and avoided maintenance costs
savings can easily be worked out as follows:

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a) VEHICLE OPERATING COST SAVINGS

Vehicle operating costs include insurances, fuel, oils, tyres and other consumables
such as spare parts, labour charges during repair, standing time during repairs etc. It
is the duty of the planner to work out the various components of these costs at
various road roughnesses for each vehicle class. For example, in the following table
had established that the vehicle operating costs were as follows:

VOC for average road surface roughness (Ksh)

10,000 2400 mm/km Saving per Saving per
mm/km vehicle/day vehicle/year
Cars 1.01 0.58 0.43 156.95
Light Goods 1.93 0.9 1.03 375.95
Vehicles
Medium Goods 2.25 1.31 .94 343.10
Vehicles
Heavy Goods 3.61 2.20 1.41 514.65
Vehicles
Buses 1.79 1.16 0.63 229.95

One would therefore work out the annual Vehicle operating costs savings for the
forecast traffic for each vehicle class.

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Year Cars L.G M.G H.G Buses Total
Saving
s
No Voc No Voc No Voc No Voc No Voc
savings savings savings savings savings
97 14 2197.3 69 25940.5
5
98 14 2197.3 71 26692.4
5
99 14 2197.3 73
00 15 75
01 16
02 16
03 17
04 18
05 18
06 19
07 20
08 21
09 21
10 22
11 23
12 24
13 25
14 26
15 27
16 28

MAINTENANCE COSTS SAVINGS

One would also work out the avoided maintenance cost savings by considering the
maintenance costs and cycles of various alternatives. For example, the maintenance
costs of a gravel road is as follows:

Routine Maintenance (or annual maintenance)

Traffic per day Annual Routine Maintenance Cost (Ksh/km/year)

0-30 600
31-100 1000
101-200 1600
201-300 2600
Over 300 3600

Gravelling (or periodic maintenance) = Ksh 160,000/ km carried out at the following
cycle

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Traffic Cycle (Years)
0-200 5
200-300 4
300-500 3
501-800 2
Over 800 1

For bitumen roads

Routine Maintenance Costs

Traffic (vpd) Sh/km/year

501-1000 160,000
1001-2000 240,000
Over 2000 320,000

Periodic Maintenance = Ksh 600,000/ cycle which is as follows

Traffic (vpd) Cycle (Years)

Over 2000 4
1001-2000 5
501-1000 6
Under 500 8

The total annual costs are allocated to each year for each alternative project and the
difference between the cases with or without the project worked out for each year.

TIME SAVINGS AND ACCIDENTS

Unlike in the case of for vehicle operating costs savings where the savings are in
monetary values, value functions have to be worked out for time, accidents etc. As
discussed above the value of time and accidents would be estimated by the principle of
willing to pay. Different people value time differently. Moreover in an economy where
most people are unemployed, questions arise as to what they would with the time
saved.

One study carried out in 1996 gave the following as the time savings rate for Kenya. By
that time the rate of unemployment was lower.

Vehicle type C LG MG HG B
Savings (K 3.45 9.80 16.62 34.78 25.7
pounds/hour
)

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One would therefore work out the time saved by each class of vehicle by estimating the
speed of travel on the roads being compared. The daily time savings for each class of
vehicle is multiplied by 365 journeys per year and the total time savings per year per
fleet computed. Note traffic levels are also changing annually.

The Supply Curve and the principles of evaluation

The supply curve shows the amounts of a good that producers are willing to supply at
various prices. Each producer is faced with some combination of fixed and variable
costs which contribute to the total cost of each output. The variable cost is zero when
the output is zero. And it increases as the output increases.

The marginal cost of an increase in production is the increment in the total cost that
comes from each increment in output of a producer. In a perfectly competitive market a
firm can sell as much as little as it likes at a fixed price per unit. The marginal revenue
of a firm is equal to the extra income it receives for each extra unit of production it
sells.
It is possible to plot a marginal revenue curve and a marginal cost curve. From these it
is possible to demonstrate that a firm maximizes its profits if it produces up to a point
where the marginal revenue equals the marginal cost.

This discussion focuses on a firm that produces one commodity. For firms producing
two or more commodities it is necessary to introduce the concept of transformation
function. The transformation function shows the combination of outputs that can be
produced for a fixed production budget. This is like a country that has too many
products to give to its citizens at a fixed budget. For example, as the production of
one commodity increases the production of the other must be curtailed, and the
transformation function shows the rate of substitution.

A set of isorevenue lines may be plotted for various production levels of the
commodities. Points along the any one of these lines represent combinations of output
that would yield the firm constant revenue. Any way that is too much economics, the
bottom line is that for a profit-maximizing firm the marginal revenue must equal
the marginal cost for each product.

Conditions for General Equilibrium

We have just discussed the conditions which determine the equilibrium positions of
consumers and producers. Now we discuss the conditions that yield welfare
maximization. The welfare of a society depends in the broadest context upon the
satisfaction levels of all its consumers where these satisfaction levels derive from the
amounts of goods and services consumed by individuals.

Welfare economics is concerned with the determination of the appropriate distribution

of inputs among the various goods to be produced and the appropriate distribution of
outputs among consumers. Economic efficiency is defined in the following way. The
distribution of goods among consumers is efficient if every possible reallocation of
goods among consumers results in the reduction of the satisfaction of at least one

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 consumer. Production is efficient if every feasible reallocation reallocation of
inputs among producers decreases the output level of at least one firm.

Simply put the aim of welfare economics is to assess the desirability of alternative
allocation of resources. The Pareto criterion considers a reallocation of resources
to be an improvement in the welfare if at least one person is made better of
without making anybody worse off.

The decision criteria based on the above principles include the benefit cost ratio,
the net present value and the Internal Rate of Return.

Example of the computation of these parameters

Year Economic Benefits Present Value Present Value Present Value

costs Discounted at 12% Discounted at 20% Discounted at
14%
Costs Benefits Costs Benefits Costs Benefi
ts
94 8935 7979 7443 7436
94 8935 7121 6201 6871
95 8935 6362 5164 6031
96 3282 2087 1582 1943
97 3936 2232 1582 2043
98 4029 2043 1350 1837
99 4214 1905 1176 1686
00 4383 1771 1021 1538
01 4520 1632 877 1397
02 3642 1173 590 983
03 5257 1509 710 1246
04 4935 1268 553 1031
05 5094 1167 412 927
06 5283 1083 412 845
07 5428 993 353 760
08 4667 761 252 574
09 5800 847 261 626
10 6437 837 245 612
11 6197 719 192 514
12 6448 671 168 471
13 6652 619 146 426
14 5891 489 106 330
15 7140 528 107 350
Discounted Totals 21462 24334 18808 12095 20338 20139
Benefit/Cost Ratio 1.134
Net Present Value 2872 -6713 -199
Internal Rate of Return 13.87%

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1. The net present value (NPV) is the difference between the sum of benefits and
the sum of costs discounted at the rate of the opportunity cost of capital in a country
which was taken as 12% in the early 2000. The project is viable if the NPV is positive.

2. The Benefit/Cost Ratio is the ratio of the sum of benefits and the sum of costs
discounted at the same opportunity cost of capital (12%). A project is viable if the
Benefit/Cost Ratio is greater than one.

3. Internal Rate of Return is the discount rate at which the Net Present Value is
zero. It is therefore obtained by a process of reiteration. However, through experience
one can estimate the discount rate at which the NPV will be positive and another at
which NPV will be negative. One would therefore use the proportionality of triangles to
work out the I.R.R. A project is viable when the I.R.R is greater than the
opportunity cost of capital in the country.

2872

2–X 14%
12%
x

199

0 NPV

2872 = 199
X 2-X

2872 (2-X) = 199X

5744 – 2872X = 199X

5744 = 3071X

X = 1.37

∴ Zero NPV is at 12 + 1.37% = 13.37%

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One can evaluate a system of roads using a number of variables as shown below

Table-Traditional benefit-cost analysis of a freeway system in the UK.

System Vehicle Capital User PV user Savings- Marginal

No miles costs (us$) savings savings in costs user
produced in millions (millions millions of savings-
(millions) of $ per $ per year) marginal
year) costs
1 1.5 90 27 229.5 139.5 -
2 1.82 110 35 297.5 187.5 484
3 2.11 140 39 331.5 191.5 4
4 2.30 180 41 348.5 168.5 -3
5 2.45 230 42 357.0 127.0 -41.5

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