CHAPTER THREE

PROJECT PREPARATION
Semester II, 2011
(FEASIBILTY STUDIES)
hatakelt@yahoo.com

prepared by Atakelt Hailu

 Feasibility studies
• Project preparation also called feasibility study
• Feasibility studies are detailed analysis of the project in different
dimensions that lead to an investment decision.
– A feasibility study should be conducted to determine the
viability of an idea BEFORE proceeding with the development of
a business.
– It provides information required for the project appraisal.
• It Is a preliminary study undertaken before the real work of a
project starts to ascertain the likelihood of the project's success.
• it looks at the viability of an idea with an emphasis on identifying
potential problems and attempts to answer one main question:
– Will the idea work and should you proceed with it?
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 Why Feasibility Study?
 To assess the merit of your business idea
 To find if there is adequate demand for the project’s
output.
 To find if there is availability of suitable technology and
inputs
 To find the best options
 To answer if the project meets the environmental
regulations and priority of the nations
 To examine the project’s financial and economic viability
 To know the Characteristics of likely customers (such as
demographics and buying behavior)
 To understand the Characteristics of likely competitors
prepared by Atakelt Hailu
Major Areas of Analysis in Feasibility study

1. Market analysis

2. Technical analysis

3. Organizational analysis

4. Financial analysis

5. Risk analysis

6. Economic analysis

7. Social analysis, and

8. Environmental analysis
prepared by Atakelt Hailu
 Major Areas of Analysis in Feasibility study
1. Market Feasibility:
 Includes a description of the industry, current market, anticipated future market potential,
competition, sales projections, potential buyers, etc.
2. Technical Feasibility:
 Deals with how you will deliver a product or service (i.e., materials, labor, transportation,
where your business will be located, technology needed, Plant Capacity, production process
etc)
 how your business will produce, store, deliver, and track its products or services.
3. Organizational Feasibility:
 Defines the legal and corporate structure of the business (may also include professional
background information about the founders and what skills they can contribute to the
business).(form of business ownership, Organizational Structure, manpower ,job title and
description )
4. Financial Feasibility:
 estimate how much start-up capital is needed, sources of capital, returns on investment, etc.
5. Economic feasibility and social analysis–
 to See its contribution to national economic- economic return, employment opportunities,
contribution to GDP, saving of foreign exchange, Tax income for the gov’t)
6. Environmental Analysis:-
 environmental impact of project mustprepared by Atakelt(water,
be analyzed Hailu air, erosion, forests, noise)
 Main Components of a feasibility study
• Cover page
• Table of contents
• Purpose of the document
• Executive summary
• Project Background and Basic Ideas
• Methodology of feasibility study
• Market feasibility
• Technical feasibility
• Organizational feasibility
• Financial feasibility
• Economic feasibility
• Environment impact analysis
• Conclusion
• Reference prepared by Atakelt Hailu
 Main Components of a feasibility study
1. Executive Summary

 Summery of feasibility study

 The executive summary should concentrate on and cover
all critical aspects of the study, such as the following:
• The degree of reliability of data on the business
environment;
• Project input and output;
• The margin of error (uncertainty, risk) in forecasts
of market, supply and technological trends; and
• Project design.

prepared by Atakelt Hailu

 The executive summary should have the same
structure as the body of the feasibility study, and
cover - but must not be limited to - the following
areas
1. Summary of the project background and history
2. Summary of market analysis and marketing concept
3. Technical analysis :-Raw materials and supply , Location, site and
environment , Engineering and technology
4. Organization and overhead costs
5. Human resources
6. Project implementation schedule
7. Financial analysis and investment potentials

prepared by Atakelt Hailu

 2. Project Background and Basic Ideas

 Description of the Business/project idea with its

background
 The project should be described in detail and the sponsors
identified, together with a presentation of the reasons for
their interest in the project.
This part of the feasibility study covers:
i. Description of the project idea
ii. Project promoter or initiator
iii. Project history
iv. Content of Feasibility study – analysis
v. Cost of preparatory studies and related
investigations, like R & D and others.
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 3. Market Feasibility:
Includes a description of the industry, current
market, anticipated future market potential,
competition, sales projections, potential buyers,
customers behaviors, etc.

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 4. Technical Feasibility
• Every project must be technically feasible.
 Details analysis of how your business will produce, store, deliver, and
track its products or services. (i.e., know how production is produced,
location and site selection, appropriateness of technology, experts and
material input, human resource, suitability of production process,).
 It deals with Selection of technology, material input and utilities,
plant capacity, location & site, machinery and equipment, project
charts and layouts.
 Technology Selection :-Appropriate technology should be selection(use local
input and utilize local manpower
 Raw Materials and Supplies Study :- Different materials and other inputs
required for operating the project should be identified and their availability,
supply and method of estimating operating costs should be analyzed.
 Location and Site :-identify suitable locations and Select attractive site within
the selected location
 Production Program and Plant Capacity:- A production program should
define the levels of output to be achieved during specified periods related to the
sales forecast.
 Machineries and equipments prepared by Atakelt Hailu
 …...........
• Technical analysis is related to examine whether
the project under study is technically feasible to
setup and operate to produce service/product.
• For example, in agriculture project of Apple
farming:-
• types of field,
• soil test,
• temperature required in selected location,
• location selection,
• plantation distance of between plants, variety etc
needs to be analyzed.

prepared by Atakelt Hailu

 5. Organizational/ Institutional analysis
• Analysis aims to ensure that:-
• The project is institutionally sound and adequate capacity exist for a
successful implementation
• The institutional arrangements facilitate effective and sustainable
operations and maintenance of the project
• It assesses the soundness of institutional arrangements for
implementing the Project.
• It covers:
• ORGANISATIONAL arrangements
• adequacy of PERSONNEL & examines their
HIERARCHICAL line of authority.
• FINANCIAL MANAGEMENT processes, including fund
flows, capacities of the people involved.
• Institutional appraisal normally would highlight capacity gaps
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 ... Organizational/ Institutional analysis
 Defines the legal and corporate structure of the business , assign role
and responsibility as well as estimate human resource requirement
(may also include professional background information about the
founders and what skills they can contribute to the business).
• A design of the organization usually includes the following steps:
1) Goals and objectives of the business are stated
2) Then functions are identified /Functions are grouped or related
3) Organizations structure or framework designed
4) All key jobs are analyzed, designed, and described
5) A recruitment and training program prepared.
It answers the following questions:
 Are authority and responsibility properly linked?
 Does the organizational design encourage delegation of authority
or do too many people report directly to the project director?
 is the project manageable? Team building, motivation of
employees and managers etc
prepared by Atakelt Hailu
Organizational Feasibility involves :-
1. Form of Business Ownership
Sole/partnership/corporation
2. Organization structure
 A division of the Company into organizational units, in line with the
marketing, supply, production and administrative functions is necessary for
efficient management of operations and designing a proper organizational
structure in accordance with the corporate strategies and policies
 It is simply a diagram or chart of all the positions in an organization and
their formal relationship to one another.
General Manager

Executive Secretary

Marketing Production Finance Personnel

Manager Manager Manager Manager R&D

workers

Executive Secretary
3. Manpower/ Job Analysis
• states the qualifications and requirements for a particular job (job
title, description and job specification)
– Ex: Job Title: Accounting Officer
»Job Requirement::-college graduate, -at least 6 months
experience as accounting officer
»Job Description:
• handles the money received from day-t-day operation of the
business
• supervises the preparations of the statement of account and
maintain the accounting records.
»Salary: 8000 birr per/month prepared by Atakelt Hailu
 6. Financial analysis
how much start-up capital is needed, sources of capital, returns
on investment, etc
 Financial analysis requires the determination of project
cost, Means of financing, estimation of sales and
production, Cost of production and Working capital
requirement as well as net cash flow and the evaluation of
the desirability of the project using various criteria
• Financial analysis consists determination of the ff:
– Cost of project,
– Means of financing,
– Estimates of sales and production
– Cost of production
– Working capital requirement
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–
 7.Risk Analysis
• both technical and economic information is used in the
form of forecasts and is subject to considerable
uncertainty.
• A project risk may be defined as any event that prevents or limits the
achievement of project objectives as defined at the outset of the
project, and these objectives may be revised and changed as the
project progresses through the project life-cycle.
• Risk management is gaining significance and importance
due to:
– increasing market competition,
– increasing technology and
– an increasing interest rate

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Potential Negative Risk Conditions Associated With Each Knowledge
Area

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 …risk
• Faulty predictions/ sources of error may be in any of the following:
– Problems in Prediction of technical performance:
• Under-estimation of the project life time
• The quality & quantity of raw materials,
• Supply of imported inputs and spare parts
• Wrong assumptions of the physical quality and quantity of your
product
• Wrong rate of production expansion (production capacity)
• Problem with the quality of the management skills.
• Prediction of the market and finance situation:
• Wrong estimation on cost of investment
• " " about the volume of demand
• " " of cost of inputs
• " " of operating costs
• " " the value of output
• Prediction of macroeconomic conditions
• Inflation rate may rise above expected
• Interest rate may rise aboveprepared
expected
by Atakelt Hailu
 …risk
• There are several ways of incorporating uncertainty:

• Adding an item called "Contingency" (in %)

• Adding "a risk premium" to the discount rate, i.e.

use a higher discounting rate (NPV decreases)
• Shorten the "life of the project"

• Use “Sensitivity Analysis".

prepared by Atakelt Hailu

 8. Economic feasibility study
• Economic analysis :-To See its contribution to national
economic:- economic return, employment opportunities,
contribution to GDP, saving of foreign exchange,
•Criteria for economic profitability:
– Project contribution in job creation.
– Tax income for govt
– project contribution for balance of payments. And GDP

prepared by Atakelt Hailu

 9. Social analysis
is a technique of evaluating projects from social perspectives.
 primarily used in evaluating public sector projects
To examine social implications of the project such as:
Poverty,
income distribution to the low income group (eg. employment
opportunity)
quality of life,
 Gender,
Health,
Ethnic considerations and Sense of empowerment and security.
 Beneficial or harmful effects of a project to the society
Examples ;-acess to raod, sewerage service, energy lines, flood
control dam
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 SOCIAL COST-BENEFIT ANALYSIS
 is a technique of evaluating projects from
social/economic perspectives.
 primarily used in evaluating public sector projects
Form of more general tool of cost benefit analysis
Undertaken from nation/economy point of view
 it is measure of cost benefit of a project to the society
Social Cost-Benefit Analysis (SCBA) is the social appraisal of
projects.
is used for determining the attractiveness of a proposed
investment in terms of the welfare of society as a whole.

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Example: The possible Social costs and social benefits for
‘construction of a bridge on a river’ project.

Social Costs Social Benefits

• Increased pollution • employment
during construction
to
workers during
• migration of labor from
farming construction
• shortage and price • less cost in travel and
increase of raw transportation
materials
• unemployment to
• saving of time of
people engaged in people, and
ferries/boat makers • employment in toll
• loss of farms and houses tax collection, if any.
of some families, if any. 25
 10. Environmental Analysis:-
 Environmental impact of project must be analyzed
 Identification and analysis of adverse effects on the environment
 Identification of positive and negative impacts
• Pollution (water, air, erosion, forests, noise , terrestrial wildlife,)
• Environmental degradation
• Required Mitigation measures and Designing environmental management
plan
• Provision of fund for environment management plan
• Some of the examples of the questions to be asked are:
• What chemicals and wastes are emitted from the project that will pollute
air and water?
• What hazardous chemicals are used that will harm the health of
employees and the people living around the project area?
11. Conclusions:
• Discusses how the business can succeed.
• The conclusions of the feasibility study should outline in depth the various
scenarios examined and the implications, strengths and weaknesses of each.
12 . Reference
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 1 Market/ Demand Analysis:
• Once you have identified your idea, the next step is preparing the
market feasibility study.
• Market feasibility study is considered to be the most important study of the
detailed studies.
– because , you cannot continue further Steps or process if the result of the
market feasibility study is negative
• The first step in project analysis is:
• to estimate the potential size of the market for the product proposed
to be manufactured and
• get an idea about the market share that is likely to be captured.
• Market/demand analysis cover mainly:
– Aggregate demand for the product/service
– The share of unfulfilled demand
– Demand forecasting
– Market price of product/service
– Analysis of competitors, their strength weakness
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 In Market Analysis:-
1.Product Description
• Detailed description of the nature of the product and its major uses;
2.Determine the target market of the product
3.Identification of customers, their needs and behaviours
• Why the proposed product is bought? (what is the purchasing motive?)
• Who are the buyers? (exports may have to be thought)
• When is the time of purchase? (seasonality)
• How much and how frequent? (quantity and frequency)?
• Where is the purchase usually made?
4.Market segmentation based on:
• Geographic criteria
• Socio-demographic criteria (age, sex, income, education, profession, size...)
• Psychological criteria (status etc.)
5.Estimate of the actual maximum possible demand of the
total market.
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• The key steps involved in market and demand analysis
are organized into the following sections :
1. Situational analysis and specification of
objectives

2. Collection of secondary information

3. Conducting market survey

4. Characterization of the market

5. Demand forecasting

6. Uncertainties in demand forecasting

7. Market planning.
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Sequence of activities in Market and Demand Analysis
Collection of
Secondary Demand
Information Forecasting

Situational Analysis Characteriz

and Specification of ation of the
Objectives Market

Conduct of Market Market

Survey planning

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 1. Situational analysis and specification of objectives
• Situational Analysis provides the current status of the key aspects of the market and
is participants.
• Is conducted to get a clue as to how the product is related with the market.
• Process stands with informal discussion with customers, competitors, middlemen
and others in the industry
• Customers: customer’s preferences & purchasing power
• Competitors: strategies & actions of competitors, and
• Middlemen: practices of middlemen
• In so doing the analyst tries to understand the preferences and purchasing power
of customers, actions and strategies of competitors, and practices of the
middlemen.
• If such situational analysis generates enough data to measure the market and get a
reliable handle over projected demand and revenues, a formal study need not be
carried out.
• But in most case , situation analysis may generate data that will provide a vague idea
of the market and provide a basis for rough demand and revenue projection. In this
case a formal study of the market and demand is warranted which means situational
analysis need to be expanded and articulated with grater clarity.
• If additional information is needed, formal study willprepared
be conducted
by Atakelt Hailu and it is
 ……Situational analysis and specification of objectives
 Objectives are specified by setting questions whose answer is supposed
to help us to meet the objectives in the market and demand study.
• Example.
• Suppose we wanted to establish Pure Milk processing business in
Addis and The management want to know where and how to market
the milk product. The objectives of the market and demand analysis
may be to answer the following questions:
 What you are going to sell? (Why this product not the another?
 Who are the buyers of proposed milk?
 What is the current demand for Milk?
 How is demand distributed over years and geographically?
 What is the component demand of milk of various sizes?
 What Price will the customers be willing to pay?
 How can potential customers be Convinced about product
 What Distribution channels are the most suited for the milk and
what margins will induce distributors to carry it?
 What is the estimated level of sales? prepared by Atakelt Hailu
 2. Collection of Secondary Information
 To answer the above questions, information is obtained from secondary and primary
source.
 Secondary information is information that has been gathered for some other purpose.
This Information has already been collected by other organization/ gov’t agency
 It can serve as a starting point for our market study
• The important sources of secondary information useful for market and demand analysis
in Ethiopia are:
 Census of Ethiopia:- Surveys by the Central Statistical Agency
 Information regarding Population, demographic characteristics,
household size, health service coverage
 Economic survey:- annual publication of the ministry of finance
and economic dev’t-
 latest data regarding to:-industrial production, whole sale price,
retail price, export, agricultural production,, national income etc
 Annual survey of industry :- annual publication of the central
statistic office provides information on various aspects of industry:-
number of units and state wise distribution, average number of
working days, employment, prepared by material
Atakelt Hailu consumption,, quantity of
 Cont’d
– Guidelines and annual survey of industries
– Annual bulletin of statistics of exports and imports
Annual Publications of the National bank of Ethiopia
 Total deposit and loan of banking sector, average deposit
and lending rate,
 total asset and liability of insurance and microfinance
– Industry associations
– Consultancy firms
– World bank

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 Cont’d
– Some important industry specific sources of secondary
information are:
– Example:
• Automobiles – annual report of the association of
Ethiopian automobile manufactures
• Textiles - Ethiopian textile bulletin, etc.
• Pharmaceuticals - annual report
• Electronics – Electronics information and planning
• Other industries – Cement, Beer, banks, etc.

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 Evaluation of Secondary Information
While secondary information is available economically
and readily provided, the market analyst is able to
locate
◦ its reliability, accuracy, and relevance for the
purpose under consideration.
The market analyst should seek to know:
◦ Who gathered the information and for what objective?
◦ When was the information gathered? When was it published?
◦ What was the target population?
◦ How representative was the sample?
◦ How accurately was the information edited, tabulated, and
analyzed?
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 3. Conducting market survey

 Secondary information, though useful often, does not provide a

comprehensive basis for market and demand analysis. It needs to be
supplemented with a primary information gathered through a market survey,
specific to the project being appraised.
 The survey could be a census; where the entire population is covered or a
sample survey; only a proportion of the population is covered.
 Information sought in a market survey may cover one or more of the
following areas:
a) Total demand and demand growth rate
b) Demand in different segments of the market
c) Income and price elasticity of demand
d) Motives for buying
e) Purchasing plans and intentions
f) Satisfaction with existing products and Unsatisfied needs
g) Attitude towards various products
h) Social economic characteristics
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Atakelt Hailu
 …CONDUCTING MARKET SURVEY…

Steps in sample survey:-

1. Define target population:-Population can be divided into different
segments. For example, by income category
2. Select sampling technique and sampling size
• Sampling techniques:- Random (probability) and non-random
(non-probability) sampling
Random (probability) sampling techniques
 Simple random sampling- each unit in the population has equal chance of
being selected
 Systematic random sampling-units of population are selected at a regular
interval. Eg. Interviewing every 10th household in the selected area of survey
 Stratified sampling- the population is broken down into homogeneous
subgroups / categories (strata) that contain similar units.
– Applied when the population has different strata.
•divide or classify the population into strata, or groups, on the basis of
some common characteristics such as sex, age, educational background
or institutional affiliation, level of management, or income, etc
•Eg. Population divided into different income groups
 ………………

3. Develop questionnaire-is a tool for collecting the desired information.

 questions should be as clear as possible
 should not be long
 avoid ambiguity
 avoid technical terms
4. Hire and train data collectors
5. Collect data and Examine the information gathered
6. Analyze and interpret the information

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 4. Characterization of the market

– Based on the information gathered from

secondary sources and through the market
survey, the market for the product/service may
be described in terms of the following:-
 Effective demand in the past and present
 Methods of distribution and sales promotion
 Price
 Consumer (Who, where, how, …)
 Supply and competition (from substitutes &
near-substitutes)
 Government policy (tax incentives, use vat or
not, …) prepared by Atakelt Hailu
 …. Characterization of the market
1. Effective demand in the past and present
- measured by determining the amount of apparent consumption
=Production + Imports- Exports- Change in the level of inventory
• Consider the following data for a specific(suger ) product introduced
to market in 2015 and compute the effective demand
Year Production Import Export Ending Effective dd
(quintal) inventory

2015 45,000 20,000 (5000) 10,000 50,000

2016 60,000 25,000 (11,000) 8000 76,000

2017 80,000 15,000 (20,000) 5000 78,000

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2. Breakdown of demand
 Total demand may be broken down into different
segments based on nature of product, consumer
groups and geographical region
 nature of the product…
.eg. In car industry:-automobiles, trucks, buses etc
in steel industry :- rolled product, various semi finished product, vehicle
cover
 Consumer groups –consumers of a product :-
 industrial consumers and individual consumer
 domestic consumers and international ,
 domestic individual consumers may be subdivided in to
different income group (high ,medium, low income
consumer ):- pricing strategy
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 …. Characterization of the market
3. Price
 Statistical information regarding price and quantity must be
gathered. Distinction must be made among:
• Manufacturer’s price
• Landed price for imported goods
• Average wholesale price
• Average retail price
4. Method of distribution and sales promotion
 method of distribution for industrial raw material differs from that
of consumer goods.
 likewise, sales promotion may be planned in a way that appeals to
customer interests based on the nature of each product.
5. Consumers
 Demographic and sociological attributes
 Age, Sex, Income , Profession, Residence, Social background
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 …. Characterization of the market
6. Supply and competition (from substitutes )
 understand the existing sources of supply (domestic or foreign)
 If domestic source of product supply , information related to
location, present production capacity, planned expansion,
 specify competition from substitutes and near substitutes
7. Government policy
 government can influence the demand and market for the
product (high tax, or tax incentive , Vat user or not, import
incentive, industrial licensing, credit control, )
 These are reflected in:
• production targets in national plans,
• import and export trade controls,
• import duties,
• export incentives, /excise duties,
• sales tax,
• industrial licensing,
• preferential purchases,
• credit controls, financial regulations
 5. Demand Forecasting
• After gathering information about various aspects of the market and demand
from primary and secondary sources, attempt may be made to estimate future
demand.
• Predicting the future Demand
• A wide range of forecasting methods are available to the market analyst. Generally, It can
be classified into two broad categories:-
1. Qualitative Methods
• Expert opinion and
• Delphi method
2. Quantitative methods
• Time series analysis
• Exponential smoothing
• Moving average
• End use method
• High-low method

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 …DEMAND FORECASTING …

1. Qualitative techniques
 relies on the judgment of experts to translate qualitative information into
quantitative estimates
 Used to generate forecasts if historical data are not available (e.g.,
introduction of new product)
 It is not based on mathematical /statistical approach
(a) Expert opinion/jury of executive
• under this method opinions are sought from a group of managers on the expected
future sales
• involves pooling of opinion from group of experts on expected future
sales and combining them into a sales estimate
• Rationale – Upper-level management has best information on latest
product developments and future product launches
• Approach – Small group of upper-level managers collectively develop
forecasts – Opinion of Group
• allows the pooling of expertise knowledge in the forecasting
process, but accuracy ofby Atakelt
prepared forecastHailu depends on the care and
(b) Delphi method
involves converting the views of a group of experts, who do not
interact face-to-face, into a forecast through an iterative
process.
It is used for eliciting the opinions of a group of experts
with the help of a mail survey.
• The steps involved in this method are:

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 Quantitative methods
• These methods generate forecasts on the basis of an analysis of the
historical time series.
– Assume that what has occurred in the past will continue to occur
in the future
• Mathematical model

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 2. Quantitative methods
a. Time Series Projection Method (Trend Projection Method)
• The change is only related to time
• Helps to forecast about the future based on what has happened in
the past
• more suitable when changes have a certain pattern and the same
pattern is expected in the future too
• Trend projection method involves the following steps:
i. Determine the trend of consumption by analyzing past
consumption statistics
ii. projecting future consumption by Yt
extrapolating
= a + bT
the trend.
• linear relationship is used, expressed as n TY   T  Y
b=
Y = a + bX n T 2   T 
2

Where
• Y is the amount of demand(expected)
• a is the intercept
• b is slope of the line
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 • Example
• To illustrate demand forecasting using Time Series Projection Method , consider the following data
concerning demand for product x during the last eight years
Year 1 2 3 4 5 6 7 8
Actual demand (past data) 200 250 175 186 225 285 305 190
• The linear equation for the above data is formulated as follows: assuming that the base
line is the first five years: Year 1 2 3 4 5
Actual demand 200 250 175 186 225

• The values of a and b can be computed as follows:

Where
Yt = a + bT • b is slope
n TY   T  Y  Y •Abisintercept
T
b= a= • Yt is demand for year t
n T   T 
2
• nT is time
2

Using the above data, the computations of a and b are as follows:

Yt = a + bT
Year (T) Actual demand (Y) TY T2 b = n TY   T  Y = 5(3,094) a=(15x1Y,036  b
) =T 70
=-1.4
1 200 200 1 n  T 2
  T 2
5(55)  (15) 2 n 50
2 250 500 4
= 1036   1.415 1036   21
3 175 525 9 = = 211.4
5 5
4 186 744 16 Yt = 211.40 -1.4T where yt is demand while t is time
5 225 1125 25 From this linear equation, we can forecast the demand
of 2006 , 2009year as,
∑T=15  = 1036 ∑TY =3,094
= 15 ∑Y=1036
∑Tx∑Y=15,540
= 3094 2==55
∑T 55 Yt = 211.40 -1.4(6)=203
(∑T) 2 =15 2 Yt = 211.40 -1.4(9)=199
 Exercise

Assume the following are the demand figures (Y) for the past six years (T)
Calculate The forecasted demand 3 years from now
T Y
T2
2013 1 23 23 1
2014 2 22 44 4
2015 3 24 9
72
2016 4 24 16
96
2017 5 25
125 25
2018 6 27
162 36
∑T=21 ∑Y=145 ∑T2= 91
∑TY=522
Yt = a + bT
n TY   T  Y  Y  b T
b= a=
n T 2   T 
2
n

b = 6(522)- 3045 87 =0.828

a= 145-0.828 (21) = 21.26
6 (91)- 441 105
6
• The forecasted demand three years from now, which will be year 9 from our analysis will be:
prepared by Atakelt Hailu
• Y9= a+ bT = 21.26 + 0.828(9) = 28.71, what about forecasted demand for 7 th year?
 2) Exponential Smoothing Method:
• Exponential smoothing is another very popular demand forecasting method.
• In this method, forecasts are modified in the light of observed errors.
• That is: ,
• the new forecast is the old one plus an adjustment for the error that occurred in the last
forecast
• new forecast (Ft+1 ) i,e next year forecasted dd= old forecast i,e last period’s forecasted
demand)+ (actual demand of last year –old forecast i,e last year forecasted) :-
• FDt+1 = FDt + α e t

• FDt+1 = FDt + α (ADt – FDt), ), or, FDt + 1 = α Dt + (1 - α ) FDt

• Where
• FDt + 1 = forecast DD for year t +1 I,e Forecast DD for the next period t
• α = smoothing parameter-weightage factor for the current demand (the smoothing
parameter which lies between 0 and 1)., If the d/c minor , it may be zero, or if the d/c is
more, it approaches to 1
• et = error in the forecast for last year t =A Dt –FDt is the forecast error (actual - forecast) for period t
• FDt Forecasted DD of period t I,e last year forecasted DD
• ADt = Actual demand of time t, I,e actual demand of last year
• The above formula can be rewritten as follows:
• FDt = FDt-1 + (ADt-1 – FDt-1)
• Where Ft = New forecast
Ft-1 = previous forecast,  = smoothing constant
ADt-1 = the actual demand for the current period ( actual demand of current period)
Example
• Assume that demand for product X in 2019 was
forecasted as 120 units (FDt-1 = 120) but Actual demand
in 2019 was 140 units (ADt-1 = 140).
• If smoothing constant is 0.4 ( = 0.40), the forecast for
2020 would be :
FDt = FDt-1 + (ADt-1 – FDt-1)
Where
Ft-1 = previous year forecast dd
 = smoothing constant
FDt = New forecast –next year forecasted dd
ADt-1 = last year actual demand =

• FD2020 = FDt-1 + (ADt-1 – FDt-1)

= 120 + 0.40 (140 – 120) = 120 + 8 = 128
prepared by Atakelt Hailu
 3) Moving Average Method:
1. Moving Average Method: According to this method, the forecast for the next period is
equal to the average of the sales for several preceding periods.
S  S t 1  ...  S t b 1
Ft 1  t
n
Where:
Ft+1 = Forecast for the next period
St = Sales for period t
n = period over which averaging is done

To illustrate, consider the following data for the past 10 years.

Year 1 2 3 4 5 6 7 8 9 10
Sales (Actual) 80 60 70 90 75 100 80 85 60 80
If the company uses a four-year moving average, sales forecast for year 5 is:
S1  S 2  S 3  S 4
4
80  60  70  90
F5 = = 75
4 prepared by Atakelt Hailu
4. End use method:
• End use method, also called consumption coefficient method, is more
suitable for estimating the demand for intermediate products.
• Intermediate products are considered output of one company
and then input of another company.
• The use of end use method in demand forecasting involves the
following steps.
• Step 1: Identify the possible uses of the product(input)

• Step 2: Define the consumption coefficient (usage rate) of the

product for various uses.
• Step 3: Project the output levels for the consuming industries

• Step 4: Derive the demand for the product.( Compute the aggregate
demand for the product by multiplying the consumption coefficient of the various uses
with their respective projected outputs and then summing up the projected demands for
the various users.)

prepared by Atakelt Hailu

 d. End use method
Industry Consumption Projected output for
Coefficient each industry

Electronics 5 10,000
Computer 4 30,000
Electricity 6 15,000
Telecommunication 7 20,000

Required: Determine the total forecasted demand for chips

prepared by Atakelt Hailu

 End Use Method
Project Demand for Indchem
•Exercise .
•A certain industrial chemical (Indchem) is used by four industries Alpha, Beta,
Gamma, and Kappa. The consumption coefficients for these industries, the projected
output levels for these industries for the year X, and the projected demand for Indchem
as shown in the following slide.
Consumption Projected Output Projected Demand for Indchem
Coefficient * in year X in year X

Alpha 2.0 10,000 20,000

Beta 1.2 15,000 18,000
Kappa 0.8 20,000 16,000
Gamma 0.5 30,000 15,000
Total 69,000
* This is expressed in tonnes of Indchem required per unit of output of the consuming
industry(usage rate)
 5. High-low method
 It involve extrapolating the past trend of demand with the identified factors
affecting the demand such as income to project the future demand
 The demand function is estimated by using these two points to
calculate the slop coefficient and the constant or intercept
 assumes a linear relationship expressed as
Y = a+bX
where
Y is demand
a is the intercept
b is the slope
x is the independent variable= income

Slope coefficient (b) is the difference between the highest demand and
lowest demand in the past divided by the difference between the highest
and the lowest of the independent variable. Mathematically,
b= (YHigh–YLow)/(XHigh-XLow)
prepared by Atakelt Hailu
(5) High-low method…
Example
consider the following observations from 5 years data.
Year Average No. of HH(X) Actual Sales (Y)
2013 46 710
2014 78 800
2015 80 1200
2016 85 1300
2017 96 1456

Average no of HH (X) actual Demand(Y)

Highest observation 96 1456
Lowest observation 46 710
Slope = change in Y =1456-710/96-46 = 14.92
change in X
Intercept or a? Y=a +bx,
1,456= a+ 14.92x 96 or 710=a+14.92 x46,
a=23.7 a=23.7
therefore, the demand equation is stated as
Demand (Y) = 23.7+14.9x
prepared by Atakelt Hailu
Example Exercise
consider the following observations from 10 years data.

Average HH Income(X) Demand(Y)

Highest observation 110 1676
Lowest observation 56 850

write the demand equation High-low method

prepared by Atakelt Hailu

• Formulate demand forecasting equation using trend projection and
High-low demand foresting method by considering the following
observations from six years data and forecast demand for the year
2021 and 2022.

Year 201 201 2017 201 2019 202

5 6 8 0
Average House hold 4 8 15 30 40 50
Income(X)
Demand(Y) 3 12 15 17 19 20

prepared by Atakelt Hailu

 ….of Market & Demand analysis
6. Uncertainties in Demand Forecasting
• Demand forecasts are subject to error and uncertainty
which arise from three principal sources:
 Data about past and present market
 Methods of forecasting
 Environmental change
7. Market Planning
• Prepare a marketing plan for the product.
• The following are the steps followed in market planning
 Current market situation
 Opportunity and issue analysis,
 Objectives
 Marketing strategy
 Action program
prepared by Atakelt Hailu