Economic Feasibility

5 minutes 5 Questions

Economic feasibility is a comprehensive study examining the cost-effectiveness of a proposed project. It measures the positive economic benefits the project is expected to provide which is then compared with the anticipated economic cost. The purpose is to validate whether the project makes sound f…

Guide to Economic Feasibility in Project Feasibility Study

Economic Feasibility is a crucial step in project feasibility study. It refers to the total cost involved and the potential economic benefits that could be incurred from a proposed project. Understanding economic feasibility is of crucial importance because it helps organizations to decide whether the potential return on a project justifies the estimated costs and risks involved.

How It Works: A comprehensive investigation of all the financial aspects of a potential project like cost required for setup, operation, upkeep, along with revenue generation, payback period are taken into account to determine its economic feasibility. It's a measure of the cost-effectiveness of the idea.

Exam tips for answering questions on Economic Feasibility:

1. Understand the Concept: Understand what economic feasibility implies within the context of the project. Show clear understanding by explaining cost implications, potential returns, and any associated risks in your answer.
2. Use Realistic Financial Estimates: If you are provided with data or if your answer requires a calculation, be sure to use realistic financial assumptions.
3. Justify Your Conclusions: Every conclusion about the feasibility of a project should be supported with sound reasoning based on your understanding and calculations.
4. Showcase Economic Understanding: Bring out different economic theories, concepts like opportunity cost, time value of money etc., to showcase your deep economic understanding, while dealing with these questions.
5. Review Your Analysis: It's important to review your analysis to ensure that you have not overlooked any costs, benefits, or potential risks associated with the project.

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CAPM - Economic Feasibility Example Questions

Test your knowledge of Economic Feasibility

Question 1

You are managing a project for new product development. The projected cash flows for the product are $30,000 per year for the next five years, totaling $150,000. The necessary investment required amounts to $90,000. The organization's approval criteria specify that for any investment, the minimum acceptable payback period should be within 3 years. How should you advise the stakeholders in this case?

Advise the stakeholders to proceed with the project as the cash flows are higher than the investment. Advise the stakeholders to proceed with the project as it meets the organization's payback period requirement and has potential for profitability. Ask to reduce the investment. Suggest to ignore the organization's approval criteria and focus on the project's potential profitability.

Correct Answer: Advise the stakeholders to proceed with the project as it meets the organization's payback period requirement and has potential for profitability.

The payback period for this investment is exactly 3 years, which meets the organization's requirement. The annual cash flow is $30,000 ($150,000 / 5 years), and in 3 years, it will generate $90,000, covering the initial investment. Moreover, the project will continue to generate cash flows for two more years, resulting in a total of $150,000, which is $60,000 more than the initial investment. This indicates potential profitability. Therefore, advising the stakeholders to proceed with the project is the most appropriate course of action.

Question 2

You're evaluating a project with a high Net Present Value (NPV) but a negative Economic Value Added (EVA). What should be your primary consideration for economic feasibility?

The alignment of the project with the company's short-term financial goals The cost of capital and its impact on long-term value creation The project's ability to maximize shareholder wealth in the current fiscal year The project's potential to generate immediate positive cash flows

Correct Answer: The cost of capital and its impact on long-term value creation

The best answer is 'The cost of capital and its impact on long-term value creation.' This is the primary consideration for economic feasibility when evaluating a project with high NPV but negative EVA.

Net Present Value (NPV) measures the profitability of a project by comparing the present value of all cash inflows to the present value of all cash outflows. A high NPV suggests that the project is potentially profitable.

Economic Value Added (EVA), on the other hand, measures the financial performance of a company by calculating the difference between its Net Operating Profit After Taxes (NOPAT) and its cost of capital. A negative EVA indicates that the company is not generating enough profit to cover its cost of capital.

In this scenario, the cost of capital is crucial because it's likely the reason for the negative EVA despite a high NPV. By focusing on the cost of capital and its impact on long-term value creation, project managers can address the discrepancy between NPV and EVA, potentially improving the project's overall economic feasibility.

The other options are less suitable:

Focusing on immediate positive cash flows may not address the underlying issue of cost of capital and could lead to short-term thinking.

Aligning with short-term financial goals doesn't consider the long-term value creation necessary for sustainable project success.

Maximizing shareholder wealth in the current fiscal year is too short-sighted and may not resolve the negative EVA issue in the long run.

For a Certified Associate in Project Management, understanding the relationship between different financial metrics and their implications for project feasibility is crucial. This answer demonstrates a more comprehensive and strategic approach to project evaluation.

Question 3

You are responsible for a project with a low Return-On-Investment (ROI) but provides significant non-monetary benefits. What is the best course of action?

Incorporate the non-monetary benefits in the ROI calculation Focus on lifting ROI regardless of the non-monetary benefits Terminate the project due to low ROI Ignore the non-monetary benefits

Correct Answer: Incorporate the non-monetary benefits in the ROI calculation

The best course of action when dealing with a project that offers substantial non-monetary benefits, despite having a low Return-On-Investment (ROI), is to incorporate the non-monetary benefits into the ROI calculation. The other answers are inaccurate for a variety of reasons. Ignoring the non-monetary benefits ignores an important aspect of the project's value, despite the fact that it is non-financial in nature. Focusing on increasing ROI without considering non-monetary benefits can lead to poor project management decisions that may overlook the project's broader impacts. Termination of the project due to low ROI fails to recognize the possibility of potential non-monetary advantages that may compensate for the low financial returns.

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