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COURSE MANUAL

Programme: BBAI. P. University (Session 200912)

Semester : VI

Subject : Project Planning & Evaluation

Code : BBA - 304

Complied By : (Prof. Pradip K. Mukherjee)

Dept. of Management

Approved By : (Prof. S. K. Dogra)

H.O.D. (Management)

BBA VI Semester, I.P. University

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304 PROJECT PLANNING & EVALUATION

Unit I :

1.0 Capital Investment: Capital expenditure is a commitment of current

resources in order to secure a stream of benefits in future years. The value of

benefits received is measured not only in terms of benefits received but also thetiming of their receipt. The net benefits of capital expenditure depend upon the

quality of investment decisions. The quality is judged by weighing the benefits

against risks & uncertainties.

1.1 Importance Capital investment decision is one of the most important

decision taken by any organization must be taken with due care because they

involve high stakes. The importance is arising from 3 inter-related reasons:

Long-term Effects : The consequences of capital investment decisions have a far

reaching effect. The present activities & functions are largely governed by

capital expenditures in the past. Similarly present capital investment decisionsprovide framework for future activities.

Irreversibility : A wrong capital investment decision often cannot be reversed

without incurring a substantial loss. The market for used capital goods /

equipment especially tailor-made to meet specific requirements may be

virtually non-existent. Once such an equipment is acquired, reversal of decision

may lead to scrapping the capital equipment leading to substantial loss.

Substantial Outlays : Capital costs tend to increase with advanced technology.

Capital expenditures usually involve substantial outlays.

1.2 Difficulties The difficulties posed can be broadly described as follows:

Uncertainty : A capital investment decision involves costs & benefits that

extend into the future which is difficult to predict exactly. This is associated

with measurement problems.

Risk element: Benefits from capital expenditure are subject to risk like

judgmental error, wrong estimation, incomplete data, unpredictability of events,

etc.

2.0 Types of Capital Investment: This are often classified by different companies

in different ways for planning & control.2.1 Physical, Monetary & Intangible Assets

Physical Assets are tangible investments like land, building, plant,

machinery, vehicles, computers, etc.

Monetary Assets are deposits, bonds, shares, etc.

Intangible Assets are different from physical assets & financial claims. They

represent outlays on research, training & development, market development,

etc. that are expected to generate benefits over a period of time.

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2.2 Other categories of investments

Strategic investment has a significant impact on the direction of the firm.

Tactical investments implement a current strategy as efficiently or profitably

as possible.

Mandatory investment is a capital expenditure required to comply with

statutory requirements viz. fire-fighting equipment, pollution control measures,

canteen facility, medical aid, etc.

Replacement investment is meant to replace worn out or obsolete equipment

with new modern equipment to reduce operating costs, increase productivity,

improve quality, etc.

Expansion investment is to increase the capacity to cater growing demand.

Diversification investment is aimed at producing new products towards

growth of the organization.

R & D investment is focused to develop new products & improved processes

to sharpen the technological edge of the company.

3.0 Phases of Capital Budgeting:

Capital budgeting may be divided into 6 broad phases

1. Planning: 2. Analysis: 3. Selection: 4. Financing: 5. Implementation:

6. Review.

3.1 Planning is concerned with broad investment strategy & preliminary

screening of project proposals. The investment strategy shows the broad

areas or types of investment the firm plans to undertake.

Once a project proposal is identified a preliminary project analysis is done.This exercise is meant to assess

1.1 Whether the project is prima-facie viable to justify a feasibility study ?

1.2 What aspects of the project are critical to its viability requiring in-depth

investigation.

3.2 Analysis If from the preliminary screening project is prima-facie acceptable,

a detailed analysis of the marketing, technical, financial, economic &

ecological aspects is undertaken.

3.3 Selection A wide range of appraisal criteria is available to judge thesuitability of the project. They are divided into 2 broad categories :

(a) Non-discounting criteria viz. pay back period, accounting rate of return, etc.

(b) Discounting criteria viz. net present value, internal rate of return, benefit

cost ratio, etc.

Criterion Accept Reject

Payback period PBP PBP < Target period PBP > Target period

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Accounting rate of return ARR ARR > Target rate ARR < Target rate

Net present value NPV NPV > 0 NPV < 0

Internal rate of return IRR IRR > Cost of capital IRR < Cost of capital

Benefit cost ratio - BCR BCR > 1 BCR < 1

3.4 Financing Once a project is selected, suitable financing arrangements have

to be made. Two broad sources of finance for a project are equity & debt.

Equity (referred to shareholders funds on balance sheets) consists of paid-up

capital, share premium & retained earnings. Debt (referred to as loan funds on

balance sheets) consists of term loans, debentures & working capital advances.

Flexibility, risk, income, control & taxes (FRICT) influence the capital

structure (debt-equity ratio) decision & the choice of specific instruments of

financing.

3.5 Implementation For an industrial project involving setting up of

manufacturing facilities consists of several stages:(a) Design & engineering Site probing, acquisition of technology, plant

design & engineering, selection of specific machineries & equipment,

prepare specifications for procurement.

(b) Purchasing & contracting Selection of vendors, issue of enquiries /

tenders, evaluation, placement of orders, receipt / issue of materials, etc.

Construction & erection Site preparation, civil works, erection &

installation of machinery & equipment, etc.

(d) Commissioning Start up the plant & stabilize operation.

(e) Training Training of all level of employees to be able to take up

responsibility that starts from the beginning.

Translating an investment proposal into a concrete project is a complex, time-

consuming and associated with risk. Delays in implementation, which are

common, can lead to substantial cost over-runs. For implementation of a

project without time & cost over-run maintaining specific quality requirements

the following are helpful:

Adequate formulation of Projects

Responsibility accounting

Network techniques for monitoring

3.6 Review Performance review must be done periodically to compare actual

performance with planned one. In case of deviation or shortfall corrective

actions are required to be taken.

4.0 Levels of Decision Making: There are 3 levels of decision making

Operating, Administrative & Strategic.

Operatingdecisions are short term with minor resource commitment, routine

matters taken by lower level management.

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Administrativedecisions are medium term with moderate resource

commitment & semi-structured taken by middle level management.

Strategicdecisions have a long term impact with major resource commitment

& unstructured taken by top level management. This influences a larger part of

the system & is difficult to undo once implemented.

5.0 Facets of Project Analysis:5.1 Market Analysis is concerned with the aggregate demand of the proposed

product/service in future and future market share of the product under appraisal.

The market analysts collect a wide variety of information as mentioned below

& decide appropriate forecasting methods:

Past consumption trends & present consumption level.

Past & present supply position.

Production possibilities & constraints.

Imports & exports.

Structure of competition. Cost parameters.

Elasticity of demand.

Consumer behavior, intentions, motivations, attitudes, preferences &

requirements.

Distribution channels & marketing policies in use.

Administrative, technical & legal constraints.

5.2 Technical Analysis covers technical & engineering aspects of a project

viz. choices of location, size, process, etc. Selection of suitable production process.

Scale of operation.

Availability of raw-materials, power & other infrastructure.

Selection of appropriate equipment & machineries.

Provision for effluent treatment & other legal/social requirements.

Realistic schedule.

5.3 Financial Analysis ascertains financial viability to generate return

expectations of the capital after meeting liabilities. It analyses: Investment outlay & cost of the project.

Means of financing.

Cost of capital.

Projected profitability.

Break-even point.

Cash flow.

Level of risk.

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5.4 Economic Analysis also referred to as social cost benefit analysis is

concerned with judging a project from the larger social point of view. It focuses

o What are the direct economic benefits & costs of the project measured in

terms of shadow (efficiency) prices & not in terms of market prices ?

o What would be the impact of the project on the distribution of income and

level of savings / investment in the society ?o What would be the contribution of the project towards fulfillment of the

certain merits like self-sufficiency, employment, social order, etc. ?

5.5 Ecological Analysis should be done particularly for major projects having

significant ecological implications with respect to pollution, soil erosion, etc. viz.

power plants, chemicals, fertilizers, refineries, steel plants, irrigation schemes, etc.

The key questions are

What are the likely damage to the environment ?

What are the cost of restoration measures required to ensure that the damageto the environment is contained within acceptable limits ?

Summary of Key Issues in different types of Project Analysis

------ Potential Market

Market Analysis --------

------ Market Share

------ Viability

Technical Analysis -----

------ Choices

------ Risk

Financial Analysis ------

------ Return

------ Benefits & Costs in shadow prices

Economic Analysis-----

------ Other Impacts

------ Environmental Damage

Ecological Analysis-----

------ Restoration Measures

6.0 Feasibility Study: is concerned with planning, analysis & evaluation, selection

and financing involving market, technical, financial, economic & ecological

analysis. Here the viability of the investment is evaluated.

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7.0 Objective of Capital Budgeting:

Capital budgeting is a part of strategic planning. The objectives is to maximize the

market value of the firm to its shareholders or shareholders wealth maximization.

Identification of investment opportunities with merit. It involve cost of capital

components Debt & Equity in making decisions of raising & investing new capital.

This is very important to organization future.

8.0 Common weaknesses in Capital Budgeting: The quality of investment

decisions are often impaired due to various deficiencies in capital budgeting like

8.1 Poor integration between strategy & capital budgeting.

8.2 Deficiencies in analytical techniques:

Base case is poorly identified For evaluating a project, the base case or status

quo scenario has to be specified i.e. what happens to the firm without the

project.

Risk is treated inadequately Options are not properly evaluated

Lack of uniformity in assumptions in multidivisional companies, project

proposals coming from different divisions tend to make varying assumptions

about economy growth rate, inflation rate, residual value, capital cost, etc.

Ignorance of side effects

8.3 No linkage between compensation & financial measures: Companies often use

discounted cash flow criteria like NPV & IRR for project selection but link

compensation to accounting measures like profit.

8.4 Reverse financial engineering the quality of information used is

compromised to fulfill certain criteria laid down by the firm.

8.5 Weak integration between capital & expense budgeting: It is often done

independently.

8.6 Inadequate post audits to compare actual performance with planned

performance.

Capital Allocation Framework:Capital is scarce & must be allocated across competing claims very judiciously. As

such the key responsibility of top management is concerned with capital allocation

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decisions. A good corporate investment program can mean sustained growth;

failure to invest wisely can impede growth or even threaten companys survival.

Key Criteria : Capital budgeting may be viewed as a 2-stage process. In the 1st

stage, promising growth opportunities are identified through strategic planning

techniques and in the 2nd stage, individual investment proposals are analyzed &evaluated in details to determine their worth.

Elementary Investment Options : The strategic planning techniques & approaches

aimed at identifying promising growth opportunities are basic long term goals &

objective of an enterprise and the adoption of courses of action & the allocation of

resources necessary for carrying out those goals. Thus strategy involves matching

firms strengths & weaknesses with the opportunities & threats present in the

external environment.Internal Analysis Environmental Analysis

Technical know-how Customers

Manufacturing capacity Competitors

Marketing & Distribution Capability Regulation

Logistics Infrastructure

Financial Resources Social/Political Environment

Strengths & Weaknesses Opportunities & Threats

Determine core capabilities Identify opportunities

______________________________________________________________Firms Strategy match between Core Capabilities & External Opportunities

Portfolio Planning Models: In multi-business firms allocation of resources across

various units / departments is a key strategic decision. Portfolio planning models

have been developed to guide the process of strategic planning & resource

allocation viz. BCG matrix, Stoplight matrix & McKinsey matrix.

BCG matrix Developed by Boston Consulting Group, this classifies the

various businesses in a firms portfolio on the basis of relative market share

and relative market growth rate as shown below:

Market share

High Low

_____________________________

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Market High Stars ?growth _____________________________

rate Low Cash Cows Dogs

_____________________________

Stars - Businesses which enjoy a high market share & a high growth rate. Theyearn high profits but require additional commitment of funds for expansion of their

activities. Eventually as growth declines & additional investment needs diminish,

stars become cash cows.

Cash Cows Businesses which enjoys a relatively high market share but low

growth potential. They generate substantial profits & cash flows but their

investment requirements are modest. The cash surpluses provided by them are

available for use elsewhere in the business.

Question Marks Businesses with high growth potential but low present market

share. Additional resources are required to improve their market share &potentially convert them into stars. As there is no guarantee of this, that is why

they are called Question Mark.

Dogs Businesses with low market share & limited growth potential. Since the

prospects for such products are bleak, it is advisable to phase them out rather than

continue with them.

As reflected above, it is apparent that cash cows generate funds and dogs, if

divested, release funds. On the other hand, stars & question marks require further

commitment of funds.

Stoplight Matrix - Developed by General Electric Co. which focuses on

Business Strength and Industry Attractiveness.

Business Strength

Strong Average Weak

High Invest Invest Hold

Industry

Attractiveness Medium Invest Hold Divest

Low Hold Divest Divest

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As reflected above, businesses which are favorably placed justify substantial

commitment of funds, businesses which are unfavorably placed call for divestment

and businesses which are placed in between qualify for modest investment.

McKinsey Matrix This has 2 dimensions viz. Industry attractiveness &

Competitive position. The criteria or factors used for judging Industry

attractiveness & Competitive position along with suggested weights aregiven below:

Industry Attractiveness Competitive position.

Criteria Weight Key Success Factors Weight

----------------------------------------------------------------------------------------------------

Industry size 0.10 Market share 0.15

Industry growth 0.30 Technology 0.25

Industry profitability 0.20 Product quality 0.15

Capital intensity 0.05 After sales service 0.20

Technology stability 0.10 Price competitiveness 0.05Competitive intensity 0.20 Low operating cost 0.10

Cyclicality 0.05 Productivity 0.10

Competitive position

Good Medium Poor

High Winner Winner Question Mark

____

Industry

Attractiveness Medium Winner Average Business Loser

Low Profit Producer Loser Loser

-----

Strategic position & Action Evaluation (SPACE) : This approach is an extension

of 2 dimensional portfolio analysis considering 4 dimensions

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Companys competitive advantage.

Companys financial strength

Industry strength

Environmental stability

The basic strategic postures associated with SPACE approach are :

1. Aggressive Posture means that the firm must fully exploit opportunities

available, seriously look for acquisition possibilities in its own or related

industries, concentrate resources to maintain competitive edge & enhance

market share.

This is appropriate for a company which enjoys a competitive advantage &

considerable financial strength and belongs to an attractive industry that

operates in a relatively stable environment.

2. Competitive Posture Maintain & enhance competitive advantage by

product improvement, widening product line, improve marketing

effectiveness and augment financial resources.

This is suitable for a company which enjoys a competitive advantage but

has limited considerable financial strength and belongs to an attractive

industry operating in a relatively unstable environment.

3. Conservative Posture Prune non-performing products, reduce costs,

improve productivity, develop new products & access more profitable

markets.

This is appropriate for a company which enjoys financial strength but has

limited competitive advantage & belongs to a not-so-attractive industry

operating in a relatively stable environment.

4. Defensive Posture Discontinue un-viable products, control costs

aggressively, monitor cash-flows strictly, reduce capacity and postpone or

limit investments.

This is suitable for a company which lacks competitive advantage as well

as financial strength and belongs to a not-so-attractive industry operating inan unstable environment.

Status Quo Concentric Diversification

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Conglomerate

Diversification Concentration

Retrenchment Turnaround

[ Page-2.25 Chandra]

Diversification Debate: The dynamism of portfolio units bring success to the

companies like Proctor & Gamble, Citigroup, Reliance, Sony, Unilever, etc.

However, conglomerate diversification is considered to be a controversial

investment strategy in-spite of the success of these companies.

The advantage claimed for conglomerate diversification that it helps a company in

reducing its overall risk exposure. In other words, Do not put all your in the same

basket.

Another benefit claimed for conglomerate diversification is that it expands

opportunities for growth. If the opportunities in the existing business are limited

because of some kind of saturation, it is natural to look at other businesses wheregrowth opportunities exist. While the prospects of succeeding in the new line of

business are often uncertain, it naturally tempt firms which have strong growth

orientation.

Some of the factors which appears to be responsible for the swing in favor of

diversification are

Desire to add 2nd and 3rd legs to overcome cyclical fluctuations.

Conservative

FOCUSAggressiveCOSTLEADERSHIP

Defensive

GAMES

MANSHIP

Competitive

DIFFEREN

TIATION

Vertical

Integration

ConcentricMerger

Conglomer

Conglomerate

Merger

Liquidation

Divestment

Diversification

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Argument of BCG group that no company was safe unless it had a portfolio

consisting of at least 3 different kinds of businesses.

Desire of many companies to gradually get out of existing industries &

move into newer ones.

Strategic Planning & Capital Budgeting:

Capital budgeting must be intimately related to corporate strategy.

Capital budgeting - multifunctional task linked to firms overall strategy.

Generally companies strive for growth of revenues, assets & profits. The

important growth strategies are concentration, vertical integration &

diversification.

Financing of Projects :

A project requires investment in land, plant & machinery, miscellaneous fixedassets, technical know-how, distribution network, working capital, etc.

Capital Structure The two broad sources of finance available are shareholders

funds (equity) & loan funds (debt). The basic differences are as follows:

Equity Debt Shareholders have residual claim Creditor have fixed claim of interest

on income & wealth of the firm. & principal payment.

Ordinarily has an indefinite life. Fixed Maturity.

Investors enjoy facility to control Investors play a passive role.the affairs of the form.

Dividend paid is not a tax deductible Interest paid is a tax deductible

payment. payment.

The key Factors in Determining the Debt-Equity Ratio for a Project

o Cost - Lenders expect a lower rate of return compared to equity shareholders

which is further reduced due to payment of tax. Debt is a cheaper but riskier

source of finance.

o Nature of Project If the assets are primarily tangible with resale / secondarymarket option, debt finance is used more e.g. manufacturing industries.

If the assets are primarily intangible without resale / secondary market

option, debt finance is used less e.g. technical know-how.

The link between the nature of assets & use of debt finance is that lenders

are more willing to lend against tangible assets.

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o Business Risk This refers to the variability of earning power defined as

profit before interest & taxes / total assets which is influenced by following

factors:

1. Demand variability Other things remaining equal, the higher the

variability of demand for the products manufactured by the firm, the

higher is the business risk.

2. Price variability A project having higher degree of volatility for theprices of its products is characterized by a higher degree of business

risk.

3. Variability of Input prices When input prices are highly variable,

business risk tends to be high.

4. Proportion of Fixed Operating costs - Other things being equal, if

fixed cost represent a substantial portion of total costs, business risk is

likely to be high. This is because when fixed costs are high, PBIT is

more sensitive to variation in demand.

Generally, the firm should be managed in such a way that the total risk borne bythe equity shareholders consisting of business risk and financial risk is not unduly

high. This implies that if the firm is exposed to high degree of business risk, its

financial risk should be kept low & vice-versa.

o Norms of Lenders The norms enforced by the lenders have a bearing on

the capital structure viz. Financial institutions earlier permitted debt-equity

ratio of 2 : 1. Now they allow debt-equity ratio 1 : 1.

o Control Considerations After deciding by the promoters own share of

investment, the extent of equity stake they want to have in a project has an

important bearing on its capital structure.o Market Conditions If the equity market is buoyant & the equity shares can

be issued at a premium, the project may rely more on equity & vice-versa.

Reasons for Preferring use of Equity or Debt

Equity Debt

Applicable tax rate is negligible Applicable tax rate is high

Business risk exposure is high Business risk exposure is low Dilution of control is not important Dilution of control is as issue

Assets of the project are mostly Assets of the project are mostly

intangible tangible

Project with many growth options. Project with few growth options.

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Menu of Financing -Finance for a project can be obtained from variety of sources.A firm can raise equity & debt capital from both public and private sources.

Capital raised from public sources is in the form of securities offered to public

through an offer document filed with SEBI. This can be traded on public

secondary markets.

Private capital may come from loans given by bank or financial institutions, etc.Besides other sources may be Internal accruals like depreciation charges &retained earnings, Working capital advance, etc.

Equity Capital represents ownership capital as equity holders collectively holdthe company. They enjoy the rewards & bear the risks of ownership. Howevertheir liability is limited to their capital contributions unlike the liability of the

owner in a proprietary firm and the partners in a partnership concern. The terms

followed are

Authorised Capital : The amount of capital that a company can potentially issue as

per its memorandum.Issued Capital : The amount offered by the company to the investors.

Subscribed Capital : The part of the issued capital which is subscribed by the

investors.

Paid-up Capital : The actual amount paid-up by the investors.

Typically Issued, Subscribed & Paid-up capital are same.

Par value : The value stated in the memorandum & written in the share certificate.

It is generally Rs. 10 /-

Issue Price : The price at which the equity share is issued. Generally issue price &

par value are same.Book value : Paid-up equity capital + Reserves & surplus -- Intangibles

No. of outstanding equity shares

Market value : The price at which it is traded in the market. This price can be

easily established for a company which is listed on the stock market & actively

traded.

Rights of Equity Shareholders :

Right to Income the equity investors have a residual claim to the income of

the firm after satisfying the claim of all other investors. The income of the

equity shareholders may be retained by the firm or paid-out as dividends as

per decision of the Board of Directors. Right to control Equity shareholders elect the Board of Directors & have

the right to vote on every resolution placed before the company. Scattered &

ill-organized, equity shareholders fail to exercise their collective power

effectively. Often the indirect control is weak & ineffective because of

indifference of most of the shareholders to attend annual general meeting

and rarely bother to cast their votes by post or proxy.

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Preference Capital - It is a hybrid of equity & debentures.

It resembles equity in the following ways

Preference dividend is payable only out of distributable profits. However it

is not an obligatory payment as it is within the discretion of directors.

Preference dividend is not a tax-deductible payment.

It resembles debenture in the following ways

Dividend rate is generally fixed.

Claim of preference shareholders is prior to the claim of equity shareholders.

Preference shareholders do not normally enjoy the right to vote.

Internal Accruals Consist of depreciation charges & retained earnings.

Term Loans The primary source of long-term debt is financial institutions &banks. This is generally repayable in less than 10 years. They are employed to

finance acquisition of fixed assets & working capital margin.

Debentures - Debentures are instruments for raising debt finance. Thusdebenture holders are the creditors of the company. Debentures often provide more

flexibility than term loans having greater choice with respect to maturity, interest

rate, repayment, etc.

Working Capital Advance - by commercial banks represents the mostimportant source for financing current assets. It is provided by commercial banks

as follows : Cash credits / Overdrafts A pre-determined limit for borrowing is

specified by the bank based on requirements & financial strength of the

company. Interest is charged on running balance & not on limit sanctioned.

This form of advance is highly attractive as borrower can draw the amount

in installments as & when required and repay as per availability of funds.

Loans These are advances of fixed amount to the borrower. The borrower

is charged interest on entire loan amount irrespective of the amount drawn.

Loans are payable either on demand or in installments.

Purchase / Discount of Bills The seller of goods draws the bill onpurchaser. On acceptance of the bill by purchaser, the seller offers it to the

bank for discount / purchase. When bank discounts / purchases the bill, it

release the funds to the seller. The bank presents the bill to the purchaser on

due date to receive the payment.

Letter of Credit is an arrangement where a bank helps its customer to

obtain credit from suppliers where the bank undertakes the responsibility to

honour the obligation of its customers.

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Miscellaneous Sources - In addition to the sources of finance mentioned, thereare several other ways in which finance may be obtained.

Deferred credit Payment for the purchases are made over a period of time.

When a deferred credit facility is offered, bank guarantee is insisted to be

furnished by the buyer.

Lease &hire purchase finance these are supplementary form of debt finance.

A lease represents a contractual agreement whereby a lessor grants the lesseethe right to use an asset in return of periodic lease rental payments e.g. land,

buildings, machineries, etc.

The hirer pays regular hire-purchase installment over a specified period of

time. These installments cover interest as well as principal repayment. After

payment of last installment, the title of asset is transferred from hiree to hirer.

Unsecured Loans & Deposits provided by the promoters to fill the gap

between the promoters contribution required by financial institutions & the

equity subscribed by the promoters.

Deposits from public represent unsecured borrowings generally of 1 to 3years duration.

Special schemes of Institutions to meet varied needs of industry designed

by different banks.

Subsidies and Sales tax deferments & exemptions Earlier central govt.

provided subsidies to industrial units located in backward areas which is

discontinued. However, to attract industries state govt. continued with

subsidies as well as incentives in the form of sales tax deferments &

exemptions.

Short term loans from Financial Institutions is provided to companies with

good track records.

Raising Venture Capital A new company unable to tap public financial marketmay seek venture capital. Such capital is provided by venture capital funds which

finance untried company having promising prospects. It represents financial

investment in a risky proposition in the hope of earning high rate of return.

Raising Capital in International Markets Due to globalization, Indian firmscan raise capital from international markets.

Financial Estimates & Projections :

Cost of Project represent total outlay associated with a project supported

by long term funds which broadly are as follows : Land & site development

Building & civil works

Plant, machinery & other fixed assets

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Technical know-how & engineering fees

Expenses on foreign experts & training of Indian employees abroad, if

applicable

Preliminary, capital issue and pre-operative expenses

Contingency

Margin money for working capital Initial cash losses

Means of Finance to meet the cost of project the following means of financeare available.

Share capital

Term loans

Debenture capital

Deferred credit

Incentive sources Miscellaneous sources

Estimates of Sales & Production Sales & Production may be estimatedtogether as they are closely related. The starting point for profitability projections

is the forecast of sales revenue.

It is advisable to assume that capacity utilization will be lower in the first year &

gradually reach the maximum level in subsequent years.

Cost of Production The major components of cost of production are : Materials cost

Utilities cost

Labour cost

Factory overheads

Working Capital Requirement & its Financing

Working Capital There is always a time gap between sale of goods & receiptof cash. Working capital is required for this period to sustain all the activities. In

case adequate working capital is not available for this period company may not be

in a position to purchase raw materials, pay wages & other expenses required formanufacturing the goods to be sold. This time gap is termed operating cycle of

the business.

The working capital requirement consists of the following:

(a) Raw materials & components (indigenous as well as imported).

(b) Stocks of goods-in-process or work-in-process.

(c) Stocks of finished goods.

(d) Debtors.

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(e) Operating expenses.

(f) Consumable stores.

The principal sources of working capital finance are as follows:

(1) Advances provided by commercial banks.

(2) Trade credit.

(3) Accruals & provisions.

(4) Long-term source of financing.The working capital requirements should be met from both short-term as well as

long-term sources of funds. The finance manager has to make use of both short-

term & long-term sources of funds in a way that the overall cost of working capital

is the lowest and the funds are available on time & for the period needed.

There are limits in obtaining working capital advances from commercial banks.

They are decided by :

(a) Lending norms followed by respective banks.

(b) Against current asset a certain amount of margin money pr0ovided.

Assessment of Working Capital Requirement:

Different methods are available

1.By estimation of different constituents of working capital individually.

2. Percent of Sales Approach based on experience and past data.

3. Operating Cycle Approach begins with acquisition of raw materials

& ends with collection of receivables. Duration of working capital or

operating cycle O = R + W + F + D Cwhere R = Raw material storage period

= ______Average stock of raw materials_____

Average raw materials consumption per day

W = Work in process period

= Average work-in progress inventory____

Average cost of production per day

F = Finished stock storage period

= ___Average finished stock inventory___

Average cost of goods sold per day

D = Debtors collection period = ____Average book debts____

Average credit sales per day

C = Creditors payment period or Credit period allowed to debtors

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= _Average trade creditors_or Average total of outstanding debtors_

Average credit purchases per day or Average credit sales per day

Compute total number of operating cycles in a year by dividing 365 days by

number of operating days in a cycle. Compute average amount of working capitalrequirement by dividing total operating expenditure in a year by number of

operating cycle in a year.

Working Capital Management

Working Capital = Current Assets Current Liabilities

Working Capital management is to manage Current Assets Current Liabilities

and interrelationship between them.

Working Capital should neither be inadequate or excessive. Current Assets shouldbe sufficient to cover Current Liabilities with reasonable safety margin. As such

different components of Working Capital are to be properly balanced

Liquidity shall be deceptive

If the proportion of inventories are very high due to slow moving or obsolete

inventory in the current assets.

If the proportion of accounts receivable is very high due to inability to

recover money from debtors in the current assets.

If a firm is maintaining a higher cash & bank balance then it is not making

profitable use of resources.

Profitability Projections The profitability projectionsor estimates ofworkingresults may be prepared along the following lines:

A. Cost of production (Cost of materials, labour, utilities & overheads)

B. Total administrative expenses (Remuneration to directors, communication &

office materials, insurance, taxes, etc.)

C. Total sales expenses (Packing, forwarding, sales promotion & advertising)

D. Royalty & know-how payable

E. Total cost of production (A+B+C+D)

F. Expected salesG. Gross profit before interest (FE)

H. Total financial expenses (Interest on loans, bank guarantee commission,etc.)

I. Depreciation

J. Operating profit (GHI)

K. Other income

L. Preliminary expenses written off

M. Profit / loss before taxation (J + KL)

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N. Provision for taxation

O. Profit after tax (MN)

Less dividend on : (1) Preference capital; (2) Equity capital

P Retained profit

Q Net cash accrual (P + I + L)

Computation of Ratios :

1.0 Profitability Ratios

1.1 Gross Profit Ratio = Gross Profit /Net Sales

1.2 Net Profit Ratio = Operating Profit / Net Sales

= Profit before Tax / Capital Employed

1.3 Return of Investment = Operating Profit / Capital Employed

2.0 Liquidity Ratio

2.1 Current Ratio = Current Assets / Current Liabilities

3.0 Leverage Ratio

3.1 Debt Equity Ratio = Debt / Shareholders Fund

4.0 Turn Over Ratio

4.1 Capital Turn Over Ratio = Net Sales / Capital Employed

Projected Cash Flow Statement The cash flow statement shows the

movement of cash into & out of the firm and its net impact on cash balance withinthe firm.

Projected Balance Sheets The balance sheet shows the balance in variousasset & liability accounts reflecting the financial condition of the firm at a given

point of time.

Format of Balance Sheet prescribed by companies act

Liabilities Assets

Share capital Fixed assets

Reserves & surplus Investments

Secured loans Current assets, loans & advances

Unsecured loans Misc. expenditures & losses

Current liabilities & provisions

The liabilities side of the balance sheet is the sources of finance employed by the

business.

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Share capital paid-up equity & preference capital.

Reserves & surplus accumulated retained earnings shown in different accounts

like capital reserve, investment allowance reserve & general reserve.

Secured loans Borrowings of the firm against security like debentures, term loans

from financial institutions & loans from commercial banks.

Unsecured loans Borrowings of the firm without specific security like fixed

deposit from public & unsecured loans from promoters.Current liabilities are obligations which mature in near future generally within a

year. These obligations arise from items which enter the operating cycle like raw

materials payment, accrual of wages, rentals, etc.

Provisions include provision for tax, provident fund, pension & gratuity,

proposed dividends, etc.

The assets side of the balance sheet shows how funds have been used in the

business.

Fixed assets Tangible resources for producing goods & services. Shown as

original cost less depreciation.Investments Financial securities owned by the firm.

Current assets, loans & advances Cash, debtors, inventories of different kinds,

loans & advances made by the firm.

Miscellaneous expenditures & losses Outlays not covered in the described asset

accounts & accumulated losses, if any.

For preparing projected balance sheet at the end of year n+1, the following

information are required:

o The balance sheet at the end of year n

o Projected income statement & distribution of earnings for year n+1

o Sources of external financing proposed to be tapped in year n+1

o Proposed repayment of debt capital during year n+1

o Outlays & disposal of fixed assets during year n+1

o Changes in level of assets during year n+1

o Cash balance at the end of year n+1

Multi- Year Projections Financial projections over a longer time frame.

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UNIT II

Market & Demand Analysis

This should be carried out in a systematic & orderly manner. The steps of Project

Analysis are as follows: Estimate the Potential size of the Market or Services

Supply Demand Gap

Patterns of Consumption Growth

Income & Price Elasticity of Demand

Composition of Market

Nature of Competition

Availability of Substitutes

Reach of Distribution Channels

Situational Analysis & Specification of Objectives:In order to get the feel of the relationship between the product and its market, the

project analyst may informally talk to customers, competitors, middlemen & others

associated in the industry.

If such a situational analysis generates enough data to measure the market & get a

reliable feedback over projected demand & revenues, a formal study may be

dispensed with keeping time & cost considerations.

However in most cases a formal study of the market & demand are warranted. An

approach to spell out objectives is to structure the objectives in the form ofquestions.

Key steps in market & demand analysis [ Refer Exhibit 4.1 of Book]

Collection of Secondary Information:Secondary information has already been gathered in some other context & is

already available. Primary information represents information that is collected for

the first time to meet the specific purpose on hand. Thus secondary information

provides the base & the starting point for the market and demand analysis. It

provides leads for gathering primary information required for further analysis.There are a number of sources available for secondary information viz. Census of

India, National Sample Survey Reports, Different Plan Reports, Economic Survey,

Reserve Bank of India, Stock Exchange Directory, State Trading Corporation

Reports

Conduct of Market Survey:Secondary information needs to be supplemented with primary information

gathered through market survey to keep a track on latest changes or developments.

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The market survey can be

o Census Survey where entire population is covered. Census survey is done

when goods are used by small numbers, otherwise it may be prohibitively

costly & infeasible.

o Sample Survey is popular for market survey practice where a sample of

population is contacted to gather relevant information. Larger the sample

size, the reliability is higher.Steps in sample survey broadly are

1. Define the target population.

2. Select the sampling scheme & sample size.

3. Develop the questionnaire.

4. Recruit & train the field investigators.

5. Obtain information as per questionnaire from respondents.

6. Scrutinize the information gathered.

7. Analyze & interpret the information.

Characterization of Market:Based on the information gathered from secondary sources & through market

surveys, the market for the products / services may be described in terms of the

following

Effective demand in the past & present.

Breakdown of demand.

Price

Methods of distribution & sales promotion.

Consumers Supply & competition

Government policy

Demand Forecasting:The future demand may be estimated after collecting information about various

aspects of the market & demand from primary & secondary sources. A wide range

of forecasting methods are available to the market analysts as follows:

1.0 Qualitative Methodsbased on the views of experts e.g. Delphi method,

etc.2.0 Time Series Projection Methodsgenerate forecasts on the basis of analysis

of historical time series e.g. Trend projection method, Exponential

smoothing method, Moving average method, etc.

3.0 Causal MethodsChain ratio method, Consumption level method, End use

method, etc.

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Uncertainties in Demand Forecasting:Demand forecasting are subject to error & uncertainty arising broadly from

following sources

Data about past & present market may be vitiated by Lack of

standardization, Few observations, Influence of abnormal factors, etc.

Methods of forecasting may face the limitations of Inability to handle

unquantifiable factors, Unrealistic assumptions, Excessive data

requirements, etc.

Environmental change may arise due to Technological change, Shift in

Govt. policy, Developments on the international scene, Discovery of new /

alternative source of materials, etc.

Market Planning: A marketing plan usually has following components Current marketing situation dealing with different dimensions of the current

situation like Market situation, Competitive situation, Distribution situation,macro-environment, etc.

Opportunity & issue analysis covering SWOT.

Objectives have to be clear-cut, specific & achievable.

Marketing strategy covers target segment, positioning, product line, price,

distribution, sales force, sales promotion & advertising.

Action plan is implementation of the strategy.

Technical Analysis

Manufacturing Process / Technology: Out of different alternatives available,

Choice of technology is influenced by a variety of considerations Plant capacity

Principal inputs

Investment outlay & production costs

Proven technology

Product mix

Latest developments Ease of absorption

Technical Arrangements: to obtain the technical know-how needed for theproposed manufacturing process.

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Material Inputs & Utilities: defining the materials & utilities requiredspecifying their properties and setting up their supply program. This may be

classified in 4 broad categories

Basic Raw Materials

Processed Industrial Materials & Components

Auxiliary Materials Utilities

Product Mix: choice of product mix is guided by market requirements. Flexibilitywith respect to product mix enables the firm to alter the production in response to

changing market conditions.

Plant Capacity: refers to the quantum of the item that can be manufacturedduring a given time period. Several factors as follows have a bearing on the

capacity decision

Technological requirements minimum economic size especially in

chemical plants.

Input constraints basic raw materials, utilities like power, water, etc.

Investment cost

Market conditions

Resources of the firm both managerial & financial

Government policy

Location & Site: the choice is influenced by proximity to raw materials &market, infrastructure facilities, availability of utilities & manpower, govt. policy,environmental requirements, etc.

Machineries & Equipment: requirement is dependent on production technology& plant capacity. There may be different types like mechanical, electrical,

instruments & controls, internal transportation system, etc.

Structures & Civil Works: cover site preparation & development, building &structures and outdoor works.

Environmental Aspects: pollutants can be gaseous, liquid or solid in addition topollution arising out of noise, heat & vibration. Proper treatment & control

facilities are to be arranged to avoid degradation of environment & health hazards.

Project Charts & Layouts: After finalizing the principal dimensions of theproject discussed project charts & layouts may be prepared to facilitate

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implementation & operation like factory & plant layout, material flow diagram,

process & instrument diagram, utility flow diagrams, etc.

Schedule of Project Implementation: Project implementation schedule isprepared to facilitate systematic execution of the project within stipulated time &

cost with the available resources. The following information are required for

preparation of schedule :

List of all possible activities from project planning to commencement of

production.

Sequence of performance of various activities.

Time required to perform various activities.

Resource requirement & allocation.

Different tools & techniques like PERT & CPM are available for preparation of the

project schedule.

Need for Considering Alternatives: There are alternative ways of transformingan idea into a concrete project. These may differ in following ways:

Nature of project may envisage manufacture of all parts & components in

an integrated unit or consist of assembly type unit which obtains the parts &

components from outside suppliers. The project may consists of processing

up to the finished stage or may stop at semi-finished stage.

Production process number of alternatives are available out of which the

best suited considering resources, absorption capability, etc.

Product quality & range shall depend on the market characteristics,consumer preferences, nature of competition, elasticity of demand, etc.

Scale of operation shall depend on economics of scale, demand pattern,

availability of resources, nature of competition, etc.

Time phasing a given capacity can be installed in one stage or in phases

suiting convenience.

Location single or multi location choice shall depend on the trade off

between economics of scale in manufacturing & logistics of distribution.

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UNIT III

Project Management

Forms of Project Organization:The traditional form of organization is quite appropriate for handling established

operations characterized by continuous flow of repetitive work with each

department attending to specific work.

However the traditional form of organization is not suitable for project

management due to the reasons

o Project is a non-repetitive, non-routine undertaking often associated with

many uncertainties.

o Relationships in a project setting are dynamic, temporary & flexible.o Project requires co-ordination of the effort of the persons drawn from

different functional areas working under time & cost pressures.

As such, there is a need for entrusting an individual (Project Manager or

Coordinator) or group with the responsibility for integrating the activities of

various departments & external agencies involved in the project work.

The project organization may be of following forms depending on the authority

given to the person responsible for project execution.

Line & Staff Organization A project coordinator is appointed with the

responsibility of coordinating the work of the people in the functionaldepartments. He acts essentially in a staff position to facilitate coordination

of line management. The project coordinator does not have authority &

direct responsibility of line management. His influence would depend on his

professional competence, closeness to top management & persuasive

abilities. This form of organization is not suitable for large projects but may

employed for small projects.

Divisional Organization A separate division headed by the project

Manager is set up to implement the project. The project manager has full

line authority over these personnel. This type facilitates the process of

planning & control, better integration of efforts & commitment of project related personnel. This form, however, may entail inefficient use of the

resources of the firm due to duplication of efforts.

Matrix Organization This seeks to achieve the twin objectives of efficient

use of resources & effective realization of project goals. Here the personnel

working on a project have responsibility to their functional superiors as well

as to the project manager i.e. the authority is shared between the project

manager & functional managers. Thus the project manager integrates the

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contribution from various functional departments towards realization of

project objectives. This is most popular form in execution of large projects.

Project Planning:Planning is a vital aspect of management which serves several important functions-

Basis of organizing different works of the project & allocating

responsibilities to individuals.

Means of communication & coordination between all involved in the

project.

Induces people to look ahead.

Instills a sense of urgency & time consciousness.

Establishes the basis for monitoring & control.

Comprehensive project planning broadly covers the following areas

Detail planning of the project work with break down of activities. Theactivities should be properly scheduled & sequenced.

Manpower planning Manpower required in different phases of the project

must be estimated realistically & the allotment of responsibilities.

Financial planning to control the expenditure in time phased manner as per

budgetary estimates & provision.

Communication, reporting & information planning for proper

implementation & monitoring / control of the project.

Tools of Planning Bar charts, Network techniques, etc.

Project Control:Control becomes the dominant concern of the project manager after the project is

launched. It involves a regular comparison of performance against targets, search

for causes of deviation & initiate corrective measures or check variances. There are

different approaches for project control adopted based on requirements &

suitability, some of which are furnished

Variance Analysis This is a traditional approach involving comparison of

the actual cost with the budgeted cost to determine the variance. This hasthe shortcoming of backward looking rather forward looking.

Performance Analysis This may be based on (a) budgeted cost for work

scheduled & work performed, (b) actual cost of work performed,

(c) Additional cost for completion, etc.

Human Aspects of Project Management:

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To achieve satisfactory human relations in project setting, the project manager

must successfully handle problems & challenges relating to (i) Authority,

(ii) Orientation, (iii) Motivation & (iv) Group functioning.

Pre-requisites for Successful Implementation:Due to time & cost over-runs, projects tend to become uneconomical, resources are

not available to support other projects & economical developments are adverselyaffected. The important areas to improve prospects of successful completion of

projects are

o Adequate formulation.

o Sound project organization.

o Proper implementation planning.

o Timely availability of funds.

o Judicious tendering & procurement.

o Efficient contract management.

o Effective monitoring & control.

Network Technique

Once the project is selected, the focus shifts on implementation. This involves

completion of numerous activities by employing various resources men,

machines, materials, money & time.

Network - A network is constructed to represent a project graphically.

It shows the position of various events & activities from start to finish.

Network Techniques broadly comprises of PERT (Project Evaluation & Review

Techniques) & CPM (Critical Path Method). These are essentially time oriented.

Objectives of Network Techniques :

Help in planning, scheduling & controlling projects.

Creates & establishes relationship between different activities of the

projects.

Helps in reducing total time & cost of the projects.

Complete the project within the stipulated period & cost. Optimum utilization of available resources.

Avoid delays & interruptions, develops discipline & systematic approach.

Steps :

Breakdown of project activities.

Estimating time requirement for each activity from similar projects or from

experience.

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Establishing relationship between precedent, subsequent & concurrent

activities.

Construction of network diagram as per sequence.

Network Logic :

I. Event An event is the beginning or completion of a task. Thus event takes

place at a particular instant of time & does not consume time or

resources.

Each event should have a distinct number.

II. Activity An activity is a definite task, job or function to be performed in a

project represented by an arrow. As such activities occur between all events and

link consecutive events in a network by an arrow. Activities consume time &

resource.

There will be only one activity between 2 events. Each activity must have a preceding & succeeding events. Not more than one

activity can have same preceding & succeeding events.

Predecessor Activity Activities that must be completed immediately prior

to the start of another activity.

Successor Activity - Activities that can not be started until one or more of

the other activities are completed but immediately succeed them.

Concurrent Activity - Activities that can be accomplished simultaneously.

Dummy Activity - Activities that consume no time or resources.

O

O O O

1. Slack is the freedom for scheduling or to start any event. An event forwhich slack is zero is critical event.

2. Float - This may be total, free or independent .

Total Float signifies the maximum delay that can be permitted in the

completion of activity without affecting project completion.

Free Float is the time an activity can be rescheduled without affecting

the commencement of succeeding activity.

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Independent Float is the time by which an activity can be rescheduled

without affecting both preceding & succeeding activities.

Presence of float in a project signifies under utilization of resources and

indicates inherent flexibility in the process.

Features of Network :1. In network diagrams arrows ( ) represent activities & circles ( O )

represent the events. Single activity can be represented once only in

the network & events should not be repeated.

2. More than 1 activity can originate from an event or lead into an event.

O O

3. Before an activity can be undertaken, all preceding activities must be

completed.

4. Designed on the basis of logical, technical & interaction between

different activities of the project.

5. The tail of the arrow represents the starting point of time of the

activity & arrow head represents completion of time of the activity.

6. There should be no loops in the project network.

Time Estimates : Generally3 time valuesare obtained for each activity.

Optimistic time (to) - shortest possible time to complete the activity ifeverything goes well i.e. without provision for any delay or setbacks.

Most likely time (tm ) - is the best estimate of time which is likely to be

accomplished.

Pessimistic time (tp) - longest time to complete the activity under

adverse conditions i.e. everything went wrong excluding force majeure

situation.

to + 4 tm + tp

Expected activity time (te ) - is computed te = ----------------

6Earliest start time (EST) of an activity is the earliest finish time of

preceding activity as network logic indicates that an activity cannot

commence until the preceding event is completed.

Earliest finish time (EFT) equals the earliest starting time plus duration

of activity.

Latest starting time (LST) is the latest finishing time minus activity

duration.

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Latest finish time (LFT) is the maximum time allowed to finish an

activity.

PERT NETWORK

This is a diagram showing the steps needed to reach a stated objective. It

depicts events, activities, interrelationship and recognizes progress to bemade in one activity before subsequent activities can begin. Thus PERT

network is a flow chart of independent events & activities each of which

must be completed to achieve project objective. This is used with

uncertain time estimates.

O----O----O----O

CRITICAL PATH METHOD

The comparison of duration of different paths identifies a path whose

duration is the longest. The path with longest duration of the project is

called the critical path & the activities are known as critical activities.

Critical activities have no float associated with them. If any activity on

this path is delayed, then entire project is affected. The critical path helpsto identify a set of activities & events which are critical and as such must

be carefully monitored & controlled.

The critical path is shown by thick or red or double line for clear

differentiation.

Characteristics

Every network has a critical path.

It is possible to have more than one critical path.

Critical path connects first to last events.

Earliest starting time is same as latest starting time

Earliest finishing time is same as latest finishing time

Crashing of a Project:

Cost plays an important role in any project in addition to time management. Time

cost relationship is of great significance in project management.

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Crash time is the minimum possible time in which the activity can be completed

and the cost associated with this time is the crash cost.

The project costs consist of both direct & indirect costs.

Direct costs can be linked directly with the activity viz. labor, material, equipment

rental charges, etc. Generally increasing the direct activity cost e.g. working over-

time by labor force can reduce the activity duration.

Indirect costs are overhead costs, interest charges, loss of revenue / benefit due tolate completion of the project, etc.

An optimal project completion time will be the time for which sum of the direct &

indirect costs are minimum. It can be observed that shortening the duration leads to

increase in direct cost but decrease in indirect costs. The strategy will be justified

only when there is net savings.

Actual time-cost relationship could be of any shape but with the assumption of

linearity for an individual activity, cost of crashing an activity by unit time is

Crash Cost Normal Cost__

Normal Time Crash Time

Procedure for Reducing Project Completion Time:

1. Identify all critical paths.

2. Compute for each activity on critical path, cost of reducing activity time

by one unitCrash Cost Normal Cost__

Normal Time Crash Time

3. Consider the activity where the cost of crashing by unit time is

minimum. However no activity can be reduced lower than the crash

time. If there is at least one critical path on which none of the activities

can be crashed then no further reduction of project completion time is

possible.

Network Cost System : The techniques of PERT & CPM overlooks the cost

aspects which are equally important. To provide a vehicle for cost planning &

control of projects, the network cost system was developed.

The costs are planned, measured, analyzed & controlled in terms of project

activities.

Actual cost --- Value of work completed

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Cost over-run (under-run) to date:-------------------------------------------------- x100%

Value of work completed

Project Review & Administrative Aspects: A project is monitored during

implementation phase so that time & cost over-runs are minimized. After a project

is completed & commissioned, the performance is reviewed to check whether it is

line with expectations.Control of In-progress Projects In spite of lot of efforts in selecting capital projects, things may go wrong in the

implementation phase. This is reflected from frequent cost & time over-runs

witnessed in practice. Hence it is necessary to exercise strict control on in-progress

capital projects. There are two aspects of control :

o Establishment of Internal Control Procedures

o Use of Regular Progress Reports

Post Completion Audits

An audit of a project after it has been commissioned is referred to as postcompletion audit. It provide a documented experience valuable in improving future

decision making with respect to capability & quality of individuals, the reasons of

generations of various pitfalls & ways adopted to overcome, etc.

Net Income

Commonly, book ROI is used which is ----------------------------------

Book Value of Assets

Abandonment Analysis Capital expenditure management is a dynamic process. With time changes may

alter the attractiveness of the project leading to the decision to determine whetherthey should be continued or terminated or divested.

A project may have to be abandoned due to its becoming non-viable. Such a

situation may develop due to one or more of the following reasons :

Change in Govt. policy

Change in the demand pattern

Obsolescence of the product

An existing concern may also become non-viable at a certain stage & may become

victim of industrial sickness. In such a situation, urgent steps are required for

prevention of sickness & the case may have to be referred to BFIR. The board goesthrough the entire case of the company & recommends a suitable rehabilitation

package or winding up as deemed fit.

Administrative Aspects of Capital Budgeting This may be categorized as follows :

Identification of promising investment opportunities.

Classification of investment.

Submission of proposals.

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Decision making.

Preparation of capital budget & appropriation.

Implementation.

Performance review.

Agency Problem

Managers as agents of shareholders are supposed to take actions that maximize thewelfare of shareholders. In practice, managers enjoy substantial autonomy with a

natural inclination to pursue their own goals. This is agency problem.

The agency problem like empire building, excessive perquisites, etc. can be

mitigated by monitoring the actions & behaviour of managers and by offering them

right incentives that motivate to maximize value.

Evaluating the Capital Budgeting System of an Organization The soundness of the capital budgeting system of an organization may be

evaluated in terms of following criteria:

Results : Are the results of the capital budgeting system consistent with the

goals of the organization ?

Techniques : Are efficient techniques being employed for purposes of

capital expenditure planning, decision making & control ?

Communication system : Whether proper communication system is adopted

between the participants of the process ?

Decentralization : Is there meaningful delegation & decentralization which

permits decision making at appropriate level ?

Adoptability : Are the policies, methods of analysis & procedures

understood by different segment of the organization ? Flexibility : Does the system have sufficient flexibility to respond to the

dynamic changes in the environment ?

Control : Are adequate controls being exercised in the implementation

phase to avoid slippage ?

Review : Is there a systematic review which permits meaningful feedback

for improving the effectiveness of the system ?

Generation & Screening of Project Ideas: The search for promising project ideas

is the first step towards establishing a successful venture. Identification of goodbusiness opportunities requires imagination, sensitivity to environmental changes

& realistic assessment of the firms capability and resources capable to generate.

Generation of Ideas Broadly the following steps are useful: SWOT analysis represents a conscious, deliberate & systematic effort by an

organization to identify opportunities that can be profitably exploited.

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Identification of objectives towards (a) Cost reduction ; (b) Increase in

capacity utilization ; (c) Improvement in quality & features ;

(d) Diversification & Expansion into promising fields with imaginative

thinking.

Fostering a conductive climate in the enterprise to motivate the employees to

think creatively & come forward with suggestions for improvement,

diversification & efficiency.

Monitoring the Environment Any progressive firm should systematicallymonitor the environment & assess its competitive abilities on the following areas:

Economic sector generally covering (a) State of economy ; (b) Growth rate

of primary, secondary & tertiary sectors and overall growth rate ; (c) Trade

surplus / deficit ; (d) Balance of payment situation, etc.

Government sector covering (a) Industrial policy ; (b) Govt. programs &

projects ; (c) Tax framework ; (d) Subsidies, incentives & concessions

available ; (e) Import & export policies ; (f) Financing norms & practices,etc.

Technological sectors like (a) Innovation of new technologies ; (b) Access to

foreign & indigenous know-how ; (c) Receptiveness & adoptability on the

part of industry, etc.

Socio-demographic sector including (a) Population trends ; (b) Income

distribution ; (c) Educational profile, etc.

Supply & infrastructure sector with respect to cost & availability of Raw

materials, energy, transportation, etc.

Corporate Appraisal A realistic appraisals of corporate strengths &weaknesses is essential for identifying investment opportunities which can be

profitably exploited. The following aspects are emphasized (a) Marketing &

distribution ; (b) Production & operations ; (c) Research & development ;

(d) Corporate resources & personnel ; (e) Finance & accounting, etc.

Profit Potential of Industries Several tools or frameworks are available likeo Porter model emphasized that profit potential of an industry depends on the

combined strength of following 5 competitive forces (a) Threat of newentrants ; (b) Rivalry amongst existing firms ; (c) Pressure from substitute

products ; (d) Bargaining power of buyers & (e) Bargaining power of sellers

o Life cycle approach which include following stages (a)Pioneering;

(b) Rapid growth ; (c) maturity & stabilization and (d) Decline.

o Experience curve is a useful tool for planning investments aimed at

reducing costs towards long-term survival & profitability of the

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firm. It stressed on the areas of (a) learning curves ; (b)

Technological advances ; (c) Economics of scale, etc.

Scouting for Project Ideas Wide variety of sources should be tapped toidentify good project ideas like :

Analyze the performance of existing industries. Examine the inputs & outputs of various industries.

Review imports & exports.

Study plan outlays & Govt. guidelines.

Scrutinize the suggestions of financial institutions & developmental

agencies.

Investigate local materials & resources.

Analyze economic & social trends.

Check new technological developments, etc..

Preliminary Screening This is required to eliminate ideas which prima-facieare not promising from the list of number of possible projects suggested. The

aspects may be checked for this purpose.

Compatibility with the promoter.

Consistency with govt. priorities.

Availability of inputs.

Adequacy of market.

Reasonableness of cost

Acceptability of risk level.Project Rating Index When a firm evaluates a large number of project ideasregularly, it may be helpful to streamline the process of preliminary screening. For

this purpose, a preliminary evaluation may be translated into a project rating index.

The steps involved are :

Identify factors relevant for project rating.

Assign weights to reflect the relative importance of these factors.

Rate the project proposal on various factors, using a suitable rating scale.

For each factor, multiply the factor rating with factor weight to get the factor

score. Add all the factor scores to get the overall project rating index.

Sources of Positive NPV Broadly there are 6 main entry barriers that result inpositive NPV projects :

Economics of scale.

Product differentiation.

Cost advantage.

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Marketing reach.

Technological edge.

Government policy.

On being an Entrepreneur The qualities & traits of a successful entrepreneurs

should covero Willingness to make sacrifices.

o Leadership.

o Decisiveness.

o Confidence in the project.

o Marketing orientation.

o Good human relations.

o Flexibility.

Every prospective entrepreneur must analyze in the following aspects1.0 Are goals well defined with respect to (a) personal aspirations ;

(b) business susceptibility & size ; (c) tolerance for risk.

2.0 Checking right strategy covering (a) clear definition ;

(b) profitability & potential for growth ; (c) durability ;

(d) rate of growth.

3.0 Capability to execute the strategy involving (a) resources ;

(b) organizational infrastructure ; (c) promoters role.

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UNIT IV

Risk Analysis Firm Risk & Market Risk: