Investment projects are basic building blocs in the development process. Gittinger claims that projects re the "cutting edge" of development. Hirschman considers them "privileged particles of the development process." In economic development, projects contribute to the integration of markets by linking productive activities, provide the organization and technology for transforming raw materials into socially and economically useful goods and services and establish the infrastructure necessary to increase exchange among organizations and geographical areas. Projects provide channels for public and private investment, rechannel unused or under employed resources into productive uses, and offer expanded opportunities for entrepreneurs.

A well-planned project passes through the following cycle: identification and definition; formulation; preparation and design; selection and approval; activation and organisation; implementation and operation; monitoring and control; termination or completion; and evaluation and follow-up analysis.

Banks and Development Finance Institutions (DFIs) are playing a very significant role in providing long-term and short-term financial assistance to projects in local as well as foreign currencies.

Prior to approving financial assistance for projects, banks and DFIs carry out detailed appraisal, which includes: (i) Sponsors’ appraisal; (ii) Technical feasibility: (iii) Market justification; (iv) Financial appraisal and (v)Economic appraisal.

(I) Sponsors’ appraisal

The sponsors’ appraisal includes the assessment of their qualifications, experience and management abilities. An essential element of sponsors’ appraisal is their credit-worthiness and reports from the financial system of the country.

(II) Technical feasibility

(a) While carrying out technical feasibility, the banks and DFIs seek to ensure that the projects are soundly designed, appropriately engineered and follow accepted technical standards. More concretely, technical appraisal is concerned with questions of physical scale, layout and location of facilities, the technology to be used including types of equipment and processes; the appropriateness to local conditions of technical standards adopted; the approach to be following for the provision of services; the realism of the implementation schedule; and the likelihood of achieving the expected levels of output.

(b) A critical part of the technical appraisal is a review of the cost estimates, and the engineering and other data on which they are based to determine whether they are accurate within an acceptable margin and whether allowances for physical contingencies and expected price increases during implementation are adequate. The technical appraisal also reviews proposed procurement arrangements. In addition, technical appraisal is concerned with estimating costs of operating project facilities and services and with the availability of necessary raw materials and other inputs. The potential impact of the project on the human and physical environment is examined to make sure that any adverse impact will be controlled and minimised.

(iii) Market justification

While examining market justification, the banks and DFIs analyse the actual consumption of the expected output of the proposed investment project as well as the following factors:

- Imports and local production.

- Nature and degree of competition (cost structure, price, quality, products or services); and merger possibilities.

- Market studies or surveys (names and competence of research team).

- Demand estimates for domestic and export markets.

- Sales forecast.

- Marketing plan.

- Sales and distribution organisation.

- Retailers marketing expertise.

(iv) Financial appraisal

Financial appraisal of a project by a bank/ DFI is concerned with its financial viability. It seeks to determine, will the project be able to meet all its financial obligations including debt service to the banks? Will it have adequate working capital? The financial viability is also analysed through projection of the balance sheet, income statement and the cash flow.

The three main tools used in financial and economic analysis are benefit - cost ratio, the net present worth and the internal rate of return.

(a) Benefit - cost ratio: The benefit - cost ratio is obtained by dividing the discounted benefit by the discounted cash flow (discounted at a cost that reflects the opportunity cost of capital).

In order to be acceptable, the projectís benefit - cost ratio must be greater than one implying that the discounted benefits exceed the discounted costs.

(b) The net present worth (NPW): This may be computed by finding the difference between the discounted benefit and discounted cost streams (both streams being discounted at the opportunity cost of capital). A project is acceptable if the NPW is positive.

(c) Internal rate of return: The internal rate of return (IRR) is the discount rate that makes the net present value equal to zero. It is the maximum interest that a project could pay for the resources employed, if the project is to recover its investment and operating costs, and still break even. In order to be acceptable, the internal rate of return must be above the opportunity cost of capital.

Aside from the aforementioned tools of financial and economic analysis, financial ratios are also used to form judgments about the efficiency of an enterprise, its returns on key aggregates and its creditworthiness.

Debt-equity ratio

This is an important ratio, which shows the relationship between debts and equity in the financial structure. Debts have fixed interest rates and these have to be met even in hard times. As such equity has to act as a cushion, which can absorb losses.

It is calculated as:

Equity

______________________________

Long tern liabilities plus equity

Sensitivity analysis

Due to uncertainty, sensitivity analysis is also undertaken to see the impact on the profitability of a project in case the future course of events happens to be different from what is anticipated. This analysis is undertaken by varying the different variables upwards and downwards by a certain percentage to see how it affects the Net Present Value (NPV) of the project. The variables tested normally are changes in prices of inputs an outputs, cost over-runs, impact on benefits due to time over-runs and changes in output yields

(V) Economic appraisal

Economic appraisal of a project is concerned with the desirability of carrying out the project from the standpoint of its contribution to the development of the national economy, whereas financial analysis deals with only costs and returns to project participants, economic analysis deals with costs and returns to society as a whole. Economically efficient projects are those, which add to national income. In economic analysis taxes, duties and subsidies are treated as transfer payments. Furthermore, some market prices are also changed to reflect appropriate economic values. These adjusted prices are often termed "shadow" or "accounting" prices. Again, in this analysis, interest on capital is never separated and deducted from the gross return, since it is a part of the total return to capital available to the society as a whole and it is that total return, including interest which this analysis is designed to estimate for the society as a whole.