A quick word here about the difference between a feasibility study, a pre-feasibility study and a scoping study. All three are studies done to test the technical and economic feasibility of a project. The difference is that they are undertaken with varying amounts of data and assumptions. In scoping studies the input criteria are almost all assumptions. In pre-feasibility studies the input criteria may be as much as 50% real data and the rest are assumptions. In a feasibility study most of the inputs are from measured data. Two estimating factors are used to cover the uncertainty in the assumptions used; the estimate accuracy and the project contingency. 

The project accuracy is a qualitative assessment of the accuracy of the capital cost estimate and is stated as, “This project capital cost estimate has a 90% probability of being within 75% and 130% of the actual project cost.” The more the estimate is based on assumptions the wider the range given to it which seems intuitive. There is nothing scientific about the ranges given. Usually they are the result of someone with lots of project experience being asked what he thinks the range should be and it seems to work.

The project contingency is a catch-all capital cost item for the stuff you forgot about and know you forgot about but can’t quite put a finger on. Again, the contingency is always higher the more assumptions are used in the project development. Scoping studies should have contingencies in the range of 40% (of the defined capital cost estimate) while feasibility studies are usually between 10% and 15%. Also if new technology is being used then the contingency will go up.

Much less attention is paid to operating costs than capital costs and this is a shame because in almost every case the operating cost has a much bigger impact on the project economics than the capital costs. When all the costs have been defined they are entered into a model which calculates the net cash flow from the annual revenue, operating costs, ongoing capital costs, taxes owing, royalties, head office expenses, marketing expenses, working capital requirements, royalties payable, interest costs etc. The annual (quarterly, monthly) net cash flows are then discounted by a factor which represents to management the kind of return they need to approve the project. The discounting formula is;

E [(annual net cash flows) / (1 + r)ⁿ]

where “r” is the discount rate in percent and “n” is the year of the project for the particular annual net cash flow. All the discounted annual net cash flows sum up to something called the Net Present Value of the project. When the net present value is equal to zero then the project has a rate of return equal to “r”. Its just one of life’s weirdnesses.

So the project is judged on its net present value, its rate of return (at the company’s price forecast), the rate at which the money is paid back and a bunch of other indicators. If the economic indicators are good enough and there is money in the kitty then the project will likely go ahead. Otherwise the feasibility study becomes a source of cheap binders for the next project.