T1 CHAP1OVERVIEW

8/2/2019 T1 CHAP1OVERVIEW

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Welcome to the

Project Appraisal and finance

by

Dr R Soundara RajanBE(Hons),AICWA,ACS,MBA,PGDCA, PGDSADP, TICK IT,CQA, Mphil, PhD
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Lecture-11. Learning Objectives:

Understand the issues in project selection and basicrequirement for planning the project

2. Outline teaching schedule:

Overview of project and project Planning

Capital investment importance and difficulties

Facet of project analysis

Key issues in major investment decisions

3. Assessment criteria

Explain the issues in capital investment andplanning process of a project


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Success comes after hardwork
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Capital Investments : Importance and Difficulties

Importance

Importance

Long term effects

Irreversibility

Substantial outlays- integrated steel plant requiresseveral thousand crores

Difficulties

Measurement problems

Uncertainty- Impossible to predict what will happen infuture

Temporal spread- cost and benefit spread over 10-20years


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Types of Investments

Mandatory Investments

Statutory like pollutioncontrol, fire fighting

Expansioninvestments-

increase capacity

R & D investments-develop new

products and process

Replacementinvestments- replaceworn out equipment

Diversificationinvestments- new

products

Miscellaneousinvestments-

interior decoration,landscape gardens


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Capital Budgeting Process

Financing- Equity, debt

Implementation- Engineering design, Contract,

Constructions,

Training, Commissioning

Selection Project worthwhile?- Apply Payback, ARR,

NPV, IRR, BCR

Analysis- marketing, technical, financial, economic

and ecological

Review- Actual performance with projected performance

Planning-Strategy, screening, feasibility, viability etc.


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Levels of Decision Making

Operatingdecisions

Administrativedecisions

Strategicdecisions

Where is the decision taken Lower level

management

Middle level

management

Top level

management

How structured is the decision Routine Semi-structured Unstructured

What is the level of resource

commitment

Minor resource

commitment

Moderate

resource

commitment

Major

resource

commitment

What is the time horizon Short-term Medium-term Long-term


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Key Issues in Project Analysis

Market Analysis

Technical Analysis

PotentialMarket

MarketShare

TechnicalViability

Sensible Choices

Financial AnalysisRisk

Return

Economic Analysis

Benefits and Costs in Shadow

PricesOther Impacts

Ecological AnalysisEnvironmental Damage

Restoration Measures


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Feasibility Study : A Schematic Diagram

GenerationofIdeas

Initial Screening

Is the Idea Prima Facie Promising

Plan Feasibility Analysis

Conduct Market Analysis Conduct Technical Analysis

Conduct Financial Analysis

Conduct Economic and Ecological Analysis

Is the Project Worthwhile ?

Prepare Funding Proposal Terminate

Terminate

Yes No

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Investment story- Firms enjoys comparative advantage vis-

a vis its competitors- positive NPV

Risks- Risk associated and ability to handle

DCF Value- NPV, IRR

Financing- Financing Mix

Key issues in major Investment

Decisions


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Objective of Capital Budgeting

Finance theory rests on the premise that managers should manage

their firms resources with the objective of enhancing the firmsmarket value. This goal has been eloquently defended by

distinguished finance scholars, economists, and practitioners.

The quest for value drives scarce resources to their

most productive uses and their most efficient users. The

more effectively resources are deployed, the more robust

will be the economic growth and the rate ofimprovement in our standard of living.


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Basic Considerations : Risk and Return

Investmentdecisions

Financing

decisions

Return

Risk

Market value

of the firm


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Common Weaknesses in Capital Budgeting

Poor alignment between strategy and capital budgeting

Deficiencies in analytical techniques

Poor identification of base case

Inadequate treatment of risk

Improper evaluation of options

Lack of uniformity in assumptions

Neglect of side effects

No linkage between compensation and financial measures

Reverse financial engineering

Weak integration between capital budgeting and expense budgeting

Inadequate post - audits


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SUMMING UP

1. Essentially a capital project represents a scheme for investing resources

that can be analyzed and appraised reasonably independently.

2. The basic characteristic of a capital project is that it typically involves a

current outlay (or current and future outlays) of funds in the expectation of

a stream of benefits extending far into the future.

3. Capital expenditure decisions often represent the most important decisionstaken by a firm. Their importance stems from three inter-related reasons:

long-term effects, irreversibility, and substantial outlays.

4. While capital expenditure decisions are extremely important, they pose

difficulties which stem from three principal sources: measurement

problems, uncertainty, and temporal spread.

5. Capital budgeting is a complex process which may be divided into six

broad phases: planning, analysis, selection, financing, implementation and

review.


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6. One can look at capital budgeting decisions at three levels: operating, administrative,

and strategic.

7. The important facets of project analysis are: market analysis, technical analysis,

financial analysis, economic analysis, and ecological analysis.

8. Financial theory, in general, rests on the premise that the goal of financial management

should be to maximize the present wealth of the firms equity shareholders. Business

firms may pursue other goals. When these other goals conflict with the goal of

maximizing the wealth of equity shareholders, the trade-off has to be understood.

9. The common weaknesses found in capital budgeting systems in practice are:

I. poor alignment between strategy and capital budgeting;

II. deficiencies in analytical techniques;

III. no linkage between compensation and financial measures;

IV. reverse financial engineering;

V. weak integration between capital budgeting and expense budgeting;

VI. inadequate post-audits.


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Oh may divine protect us both,the teacher and the disciple. May

he nourish us both. May we worktogether with great energy. Mayour study be vigourous and

fruitful. May we not hate eachother

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T1 CHAP1OVERVIEW