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Assignment

ON


MB0049Project
Management









Submitted By:

Ravinder Verma
Roll No.- 1311004378


Q.1 There cannot be a single ideal structure for all organisations as different organisations have different size,
environment, resources, technologies, and goals. There are many different ways in which people can be organised to
work on projects. Explain in brief the concept of organisational structure. ?
Organizational structure is a system used to define a hierarchy within an organization. It identifies each job, its function and
where it reports to within the organization. This structure is developed to establish how an organization operates and assists an
organization in obtaining its goals to allow for future growth. Organizational structure is the framework by which a company
communicates, develops goals and then works on achieving those goals.
Hierarchy of Command-One of the principles that holds an organizational structure together is the hierarchy of command.
Respect for the authority of management and the executive team creates a functional line of communication. Instructions and
decrees given by the upper echelon are validated by the belief in the hierarchy structure of the organization. Everyone in the
company can follow the trail of responsibility for projects, and employees understand who they report to and how the
management structure affects their jobs.
Role Definition- An efficient organizational structure helps to properly define everyone's role within the company. A clear
definition of the responsibilities and standing of each person within the company creates an understanding of what is expected
from each individual, and how individual performance can affect the efficiency of the entire organization.
Evaluating Outcomes-Monitoring the outcome of individual projects, as well as the ongoing performance evaluation of
individual employees, helps to determine the strengths and weaknesses in the organizational structure. The weaknesses can be
dealt with either through training, reallocation of company assets such as equipment, or eliminating ineffective employees or
those performing duplicate tasks. The strengths of the organization can be amplified to help identify future managers of the
company, determine successful processes that can be used in future projects, and improve the processes used to reach future
company goals.
Altering Organizational Structure-One of the key principles of organizational structure is the ability to remain dynamic and
change to suit the needs of the company. Some of the elements that necessitate change in an organizational structure include
changing customer needs, a change in company management, new technology, and reacting to the activities of your
competition.
Types of Organisational Structures-Organizations are set up in specific ways to accomplish different goals, and the
structure of an organization can help or hinder its progress toward accomplishing these goals. Organizations large and small
can achieve higher sales and other profit by properly matching their needs with the structure they use to operate. There are
three main types of organizational structure: functional, divisional and matrix structure.
Functional Structure-Functional structure is set up so that each portion of the organization is grouped according to its
purpose. In this type of organization, for example, there may be a marketing department, a sales department and a production
department. The functional structure works very well for small businesses in which each department can rely on the talent and
knowledge of its workers and support itself. However, one of the drawbacks to a functional structure is that the coordination
and communication between departments can be restricted by the organizational boundaries of having the various departments
working separately.
Divisional Structure-Divisional structure typically is used in larger companies that operate in a wide geographic area or that
have separate smaller organizations within the umbrella group to cover different types of products or market areas. The
benefit of this structure is that needs can be met more rapidly and more specifically; however, communication is inhibited
because employees in different divisions are not working together. Divisional structure is costly because of its size and scope.
Small businesses can use a divisional structure on a smaller scale, having different offices in different parts of the city, for
example, or assigning different sales teams to handle different geographic areas.
Matrix Structure-The third main type of organizational structure, called the matrix structure, is a hybrid of divisional and
functional structure. Typically used in large multinational companies, the matrix structure allows for the benefits of functional
and divisional structures to exist in one organization. This can create power struggles because most areas of the company will
have a dual management--a functional manager and a product or divisional manager working at the same level and covering
some of the same managerial territory.
Advantage & Disadvantage of Organisational Structure-Each company tends to use the business structure that suits it best
-- there is no absolute right or wrong way to structure a business. Whether a particular structure is advantageous or
disadvantageous for a company depends on the type of business, the strategy of the company, its target market and the style of
the management.
Functional Strategy Advantages And Disadvantages-In a functional structure, all of the decision-making occurs at the top
levels of management. This ensures that upper management has complete control over the organization. It also provides a
clear career trajectory for employees, from junior-level positions, up to the top decision-making positions. A functional
structure provides stability and efficiency, especially in large and complex organizations, because everyone uses similar
processes. This also allows large businesses to take advantage of economies of scale. However, this type of structure can also
lead to poor communication between departments, situations where departments do not work together and inter-departmental
conflict. Customers may also become frustrated by lack of cooperation if they have to work with more than one department.
Divisional Structure Advantages And Disadvantages-In a divisional structure, divisions are organized geographically or by
product line or marketing area and each division includes people from each area of the business. This allows the company to
respond quickly to customer needs and helps more employees develop managerial skills. The disadvantage of this structure is
that there can be a lot of redundant effort and competition between divisions.
Matrix Advantages And Disadvantages-Organizations with a matrix structure have no chain of command. Employees work
in teams, which they develop and organize. Employees can change teams to work in areas where they are needed or are
interested in working. This works very well in smaller organizations and in those businesses where resources and specialist
employees are scarce, as everyone is kept busy and can be moved around to where they are most needed. This structure
increases employee skills and involvement but can lead to employee confusion and frustration because lines of reporting are
unclear. It can also be difficult to set priorities when employees are moving between competing projects.
Q.2Write short notes on
(a)Work breakdown structure: The entire process of a project may be considered to be made up on number of sub
process placed in different stage called the Work Breakdown Structure (WBS). WBS is the technique to analyses the content
of work and cost by breaking it down into its component parts. Project key stages form the highest level of the WBS, which
is then used to show the details at the lower levels of the project. Each key stage comprises many tasks identified at the
start of planning and later this list will have to be validated.
WBS is produced by identifying the key elements, breaking each element down into component parts and continuing to
breakdown until manageable work packages have been identified. These can then be allocated to the appropriate person.
The work breakdown structure has a number of benefits in addition to defining and organizing the project work. A project
budget can be allocated to the top levels of the work breakdown structure, and department budgets can be quickly calculated
based on the each projects work breakdown structure.
When a project is falling behind, referring the work breakdown structure will quickly identify the major deliverables impacted
by a failing work package or late sub- deliverable. The work breakdown structure can also be color coded to represent sub-
deliverable status. Assigning colors of red for late, yellow for at risk, green for on-target, and blue for completed deliverables
is an effective way to produce a heat-map of project progress and draw managements attention to key areas of the work
breakdown structure.
The following guidelines should be considered when creating a work breakdown structure:
The top level represents the final deliverable or project
Sub-deliverables contain work packages that are assigned to a organizations department or unit
All elements of the work breakdown structure dont need to be defined to the same level
The work package defines the work, duration, and costs for the tasks required to produce the sub-deliverable
Work packages should not exceed 10 days of duration
Work packages should be independent of other work packages in the work breakdown structure
Work packages are unique and should not be duplicated across the work breakdown structure
(B)Rules of Network Construction:
Some basic rules for developing are:
Network flow from left to right
An Activity cannot begin until all preceding connected activities have been completed
Arrows on Network depict the precedence and flow of Activities. Arrows can cross over each other without any
impact.
Each Activity should have a unique identification number
It is acceptable to leave gaps between Activity Identifiers such as: 1, 5, 10, 15. This makes it easier to add
missing Activities at a later date without having to renumber the entire Network Diagram.
Activity Identifiers should be ascending numbers that are as simple as possible
Looping is not allowed
Conditional statements are not allowed the network diagram is NOT a decision tree
Activities can only occur once on a Network Diagram. If they are to occur a second time, they should have a different
name and new identifier.
Experience suggests that when there are multiple starts, a common start node can be used to indicate a clear project
beginning on the network. Similarly, a single project end node can be used to indicate a clear ending
There are two main approaches for developing Network Diagrams:
AON Activity-On-Node uses a node to depict an Activity
AOA Activity-On-Arrow uses an arrow to depict an Activity
AON dominates most projects
(c)Risk Retention: A method of self-insurance whereby the organization retains a reserve fund for the purpose of offsetting
unexpected financial claims in known as Risk Rtension. In the insurance world, risk retention has an even broader meaning.
Simply put, every time your policy calls for a deductible, you've retained some of the risk. In fact, risk retention is a common
strategy for businesses and individuals alike. Every automobile policy contains deductibles and some auto policy coverage
options are even declined (at least for older, fully paid vehicles) such as "Collision" and "Comprehensive." Here again is
another form of risk retention. The very act of not insuring something of value is another form of risk retention.
General liability and products/completed operations policies have either deductible or self insurance retentions (SIR), both of
which are forms of risk retention. Businesses that select self-insured reserves do so in order to gain more control over the
risk(s) that they have retained.
(d)Emerging Methods of Communication
The technical aspects of managing projects notwithstanding, project managers are increasingly asked to lead the organization
in transformative ways. Since project managers often interact across the entire spectrum of departments within corporations
and are not stuck in a certain corporate silo, they are often exposed to emerging trends within the industry that other
functional or departmental managers are not. Among the trends that project managers have noticed are:
An increased emphasis on project management soft skills
Viewing the project management office (PMO) as a potential profit center (vs. a cost center)
Aggressively planning sustainability into projects and an increased emphasis on corporate social responsibility.
Increased Emphasis on Project Management Soft Skills- There is another set of skills a project manager must master to reach
his or her full potential: soft skills,such as interpersonal communication, leadership, negotiation skills, influencing, and
personnel management. Soft skills are much more art than science. Companies that invest in the development of their project
managers set of soft skills are the ones that have the greatest chance of achieving project success
a) Communication- The ability to plan and build a communication management plan is a hard skill that doesnt require
finesse. Soft skills come into play when the project manager has to have difficult conversations, negotiate with the sponsor or
stakeholders, or to detail subpar performance to a member of a project team.
b) Leadership c) Retaining Team Members c) Coaching and Communicating d) Setting Expectations e) Mentoring
The PMO as a Profit Center- The PMO can provide functional and departmental managers with manpower and can
generate revenue by assigning these labor costs out to the other departments. It is more affordable, in almost every
instance, to use in-house SMEs than to hire an outside consultant or consulting firm. Transferring costs from one
department to the revenue stream of another department can be seen as accounting voodoo. However, the real savings and
revenue generation will be realized when the PMO must quickly reassemble a team to tackle a high-priority ,high-profit
project opportunity. Keeping the PMO staff and using them as in-house consultants.
Social Responsibility and Planning for Sustainability in Projects-
a) Sustainability b) Social Responsibility
Q.3 Purchase cycle is a standard process that corporations and individuals progress through (in order) when
purchasing a product or service. It is also known as the 'buying cycle' or 'purchase process'. Explain the elements
of the purchase cycle of a project.
Many organizations are beginning to re-evaluate their purchasing processes, and identify new types of e-procurement tools
that will meet their needs. The purchasing process basically involves the following elements:

1. Identify or anticipate material or service needs.
2. Evaluate potential suppliers.
3. Select suppliers.
4. Release and receive purchase requirements.
5. Continuously measure and manage supplier performance.
These stages may vary in different organizations, depending on whether purchasing is sourcing a new or repetitively
purchased item, and also whether there is a detailed approval process for purchases that exceed a specific dollar amount. New
items require that purchasing spend much more time up front evaluating potential sources. Repeat items usually have
approved sources already available.
A document flow accompanies the movement of orders and material throughput the purchasing process. Historically,
preparing and managing the proper purchasing documents has been a time-consuming process.. The suite of tools used to
achieve efficiency in purchasing transactions is broadly defined as e-procurement. Companies are using e-procurement
tools to manage the flow of documents by (1) automating the document generation process and (2) electronically transmitting
purchase documents to suppliers. The benefits of electronically generating and transmitting purchasing-related documents
include a)A virtual elimination of paperwork and paperwork handling b)A reduction in the time between need recognition and
the release and receipt of an order c)Improved communication both within the company and with suppliers d)A reduction in
errors e)Lower overhead costs in the purchasing area f)Purchasing personnel spend less time on processing of purchase orders
and invoices, and more time on strategic value-added purchasing activities.g)The electronic documents often used in the
process are represented in the Exhibit by boxes with cross-hatches.
1. User Need for Product or Service-The purchasing process begins with identifying or anticipating a material or service
needed by a user, and electronic documents may be used in any of the following forms:Purchase requisitions from internal
users/Forecasts and customer orders (electronically)/Routine reordering systems (barcodes)/Stock checks/Material
requirements identified during new product development
2. Purchase Approval and Supplier Evaluation-As shown in the exhibit, there may be various steps in the process required,
depending on the size of the purchase, as well as whether the company has purchased form the supplier before. Once the user
need has been recognized, the system will check to see if an approved supplier has already been entered into the database. In
many cases, for a repetitive purchase, purchasing may have already negotiated a contract with the supplier, with established
terms for delivery, pricing, quality, etc., and the supplier has already been entered into the accounting system.
3. Bidding, Negotiation, and Supplier Selection-Final supplier selection occurs once purchasing completes the activities
required during the supplier evaluation process. Selecting suppliers is perhaps one of the most important activities performed
by companies. Errors made during this part of the purchasing cycle can be damaging and long-lasting. After bids have been
received, and/or the negotiation has taken place, the sourcing team will select a supplier, and then move on to authorize the
purchase through the purchase approval process.
4. Purchase Approval-After the supplier is selected or a requisition for a standard item is received, purchasing grants an
approval to purchase the product or service. This is accomplished through an electronic drafting of a purchase order (PO),
sometimes called a purchase agreement, after supplier selection is complete. Purchasing must take great care when wording a
purchase agreement because it is a legally binding document. Almost all purchase orders include the standard legal conditions
that the order (i.e., the contract) is subject to on the reverse side of the agreement
5. Release and Receive Purchase Requirements-This phase of the purchasing cycle involves the physical transmittal of
purchase requirements. This should be a fairly routine, although not necessarily the most efficient, part of the purchasing
cycle. Some organizations transmit orders electronically, while others send material releases through the mail or by fax.
Electronic data interchange (EDI), which involves the electronic transfer of purchase documents between the buyer and seller,
can help shorten order cycle time. EDI transactions, particularly through the Internet, will increase over the next several years.
The shipping and receiving processes require several other important documents (which also can be electronic), including the
material packing slip, the bill of lading, and the receiving discrepancy report.
6. Continuously Measure and Manage Supplier Performance-One way to identify the best suppliers is to track
performance after awarding a contract. Supplier measurement and management is a key part of the purchasing cycle. As
shown in the exhibit, buyers should not assume that the purchasing cycle ends with the receipt of an ordered item or the
selection of a supplier..
Conclusion- A method used by businesses to buy products and/or services. A purchasing system manages the entire
acquisition process, from requisition, to purchase order, to product receipt, to payment. Purchasing systems are a key
component of effective inventory management in that they monitor existing stock and help companies determine what to buy,
how much to buy and when to buy it. A popular purchasing system is based on economic order quantity models. Purchasing
systems makes the purchasing process more efficient and helps companies reduce supply costs.
Q.3 Write a note on Earned Value Method (EVM)
Earned Value Analysis (EVA) is a way to measure the amount of work actually performed on a project (i.e., to measure its
progress) and to forecast a projects cost and date of completion. The method relies on a key measure known as the earned
value (also known as the budgeted cost of worked performed or BCWP). This measure enables one to compute
performance indices for cost and schedule, which tell how well the project is doing relative to its original plans. These indices
also enable one to forecast how the project will do in the future.
Earned value actually uses three data values, which are computed each week, month, or whatever other period you wish to
use. We use the term analysis date to refer to the date when the three values are analyzed. Thus if we measure these values
monthly, an analysis date of October 31 would include all values from project inception until the end of October.
The three values are:
Budgeted Cost of Work Performed (BCWP).
Budgeted Cost of Work Scheduled (BCWS).
Actual Cost of Work Performed (ACWP).
1.2 Definition of the Three Basic Values
BCWP or Budgeted Cost of Work Performed or Earned Value
This is the cost originally budgeted to accomplish the work that has been completed as of the analysis date. It answers the
question how much work has actually been completed?.
BCWS or Budgeted Cost of Work Scheduled or Plan
This is the total budgeted cost up to the analysis date. It answers the question how much did we plan to spend as of this
date? A variant of this question is how much work should have been completed by this date? BCWS can be computed
from the projects plans, as illustrated in the sequel, or it can be approximated by multiplying the total budget by the fraction
of total project duration at the analysis date. Thus, for example, if the project budget is $100 and 20% of the projects time
has elapsed, the approximate BCWS is $20.
ACWP or Actual Cost of Work Performed
This is what it actually cost to accomplish all the work completed as of the analysis date. It answers the question how much
have we actually spent?. This is usually determined from the organizations accounting system, or can often be approximated
by multiplying the number of people by the number of hours or days or weeks worked.
1.3 Derived Metrics
Four measures can be computed from the basic values described above:
Schedule Variance (SV) = BCWP - BCWS
If it is 0, you are right on schedule. If it is negative, you are behind schedule. If it is positive, you area ahead of schedule.
Schedule Performance Index (SPI) = BCWP / BCWS
If it is 1, you are right on schedule. If it is less than 1, you are behind schedule. If it is greater than 1, you are ahead of
schedule.
Cost Variance (CV) = BCWP - ACWP
If it is 0, you are right on budget. If it is negative, you are over budget. If it is positive, you area under budget.
Cost Performance Index (CPI) = BCWP / ACWP
If it is 1, you are right on budget. If it is less than 1, you are over budget. If it is greater than 1, you are under budget.
Q.4 What are the common features available in PM software packages?
An overview of generic features associated with various project management software packages available today. These
generic features include:
Data entry features
o Project data and calendar: A project start date is specified.A calendar can be used to define the working days and hours
for each individual resource on a project. The calendar is used in calculating the schedule for the project. Most systems
provide a default for the standard working period, such as Monday to Friday from 8:00 AM to 5:00 AM, with an hour for
lunch. The calendar can be modified for each resource.For example, work hours can be modified, company holidays can be
entered as non-working days, and various shifts can be entered.
o Human resources: Suppose a particular activity needs 2 unskilled person and 1 skilled person to complete the task. These
two resources may be entered separately and will appear as 2L and 1S on activity description in network.

Type of resource Amount of resource
available (No.) Period
From To
Skilled person 10
Unskilled person 100
o Labour cost: One of the many ways to specify labour cost is as,
Skilled worker -- $ 2.0 Unskilled worker -- $1.2
o Human resources available: All software requires periods and amount of resources that are available for the project.
o Cost of construction materials: Materials needed for each task and their estimated costs for the project may be as given
Various Options to Link Activities
o Data entry error: All good management software contains error detection routines that identify and reports errors.
However, there are certain errors which cannot be detected by software. These include:
An incorrect activity duration/ An incorrect activity name/ An Incorrect precedence logic/ An Incorrect cost data/ A
wrong resource entered
These errors have to be corrected manually by listing of the activity records.

Graphics: For a project involving a large number of activities,drawing a correct network, manually takes a lot of time and
effort.One of the important features of PM software is its ability to generate a variety of charts including network diagram,
activity-linked Gantt chart, and Gantt chart quickly. Further, changes in base line plan are quite easy.
Time analysis: If there is unlimited and flexible resource or if resource can be outsourced, the network may be prepared at
the earliest start time of activities. In the real world, many projects are managed on this basis.PM packages carry out time
analysis which includes calculation of early start, early finish, late start, and late finish; free slack and total slack with ease.
Manually carrying out time analysis is tedious.
Resources scheduling: Resources scheduling problems are of two types:
o Resource leveling where unlimited and flexible resources are available
o Resource allocation problem where resources are limited In resource leveling, activities are scheduled to minimise the
variation in level of resource deployment.Resource allocation problem is concerned with Scheduling activities in such a way
so as to find the shortest project schedule.
Output reports: Most PM software packages have extensive report generation capabilities. They can generate a range of
reports in various forms (graphical, tabular, or textual). The reports are standard or customized.
The content of each report for a recipient is based on a "need-to-know basis" and is presented in a particular order. These
requirements are met by two features of the software namely, filtering (editing) and sorting. Among the reports generated by
the software include:
Project schedule: Network (based on AON systems), linked Gantt chart, Gantt chart o Work-to list
Cost related report: Budgeted vs. actual cost (daily and cumulative) o Resources utilization report
Progress report: Overall project, milestone chart, critical path o Chart showing responsibility of department/function to carry
out particular activities o Progress summary report
Updating: Updating is the process of producing a fresh set of schedule and other reports to take account of one or more of
the following:
o A change to the project parameter, an unexpected increase or decrease in the resource available, changed cost rate, or new
target dates.
o A change in network logic due to change in project scope, design change, etc.
o To have a new schedule that take into account the progress made to date.
Importing/exporting: The process of bringing information into the PM software from other application such as word
processing, spread sheet,etc is called importing. Similarly, sending information from PM software to other application is
called exporting. The exporting and importing obviates typing/data entry effort and eliminates the possibility of associated
error.
Project monitoring and tracking: Tracking the progress about schedule and cost is an important aspect of project
management. Most PM software packages permit the users to define a baseline plan and compare the actual progress with
respect to those in the baseline plan.
What if analysis: This is a useful feature of PM software. This permits to know the effect of changes in project variable
(people, cost, and change in scope) on project objective. This analysis helps the project manager in taking an appropriate
decision.
Q.4 A project should earn sufficient return on the investment. The very idea of promoting a project by an
entrepreneur is to earn attractive returns on investment on the project. If there are many alternative projects, all of
which, at first sight, appear to be more or less equal in profit earning capacity, the investor should make a
comparative study of the return on the different alternative proposals before choosing one. Such financial analysis

Explain the subdivisions within the above two categories
Any investment decision depends upon the decision rule that is applied under circumstances. However, the decision rule itself
considers following inputs.
Cash flows -Project Life-Discounting Factor
The effectiveness of the decision rule depends on how these three factors have been properly assessed. Estimation of cash
flows require immense understanding of the project before it is implemented; particularly macro and micro view of the
economy, polity and the company. Project life is very important, otherwise it will change the entire perspective of the project.
So great care is required to be observed for estimating the project life. Cost of capital is being considered as discounting factor
which has undergone a change over the years. Cost of capital has different connotations in different economic philosophies. A
number of capital budgeting techniques are used in practice. They may be grouped in the following two categories: -
I. Capital budgeting techniques under certainty; and II. Capital budgeting techniques under uncertainty
2.2 Capital budgeting techniques under certainty:
Capital budgeting techniques (Investment appraisal criteria) under certainty can also be divided into following two groups:
Non-Discounted Cash Flow Criteria: - (a) Pay Back Period (PBP) (b) Accounting Rate Of Return (ARR)
Discounted Cash Flow Criteria: -
(a) Net Present Value (NPV) (b) Internal Rate of Return (IRR) (c) Profitability Index (PI)
2.2.1 Non-Discounted Cash Flow Criteria:
These are also known as traditional techniques:
(a) Pay Back Period (PBP) : The pay back period (PBP) is the traditional method of capital budgeting. It is the simplest and
perhaps, the most widely used quantitative method for appraising capital expenditure decision.
Meaning: It is the number of years required to recover the original cash outlay invested in a project.
Methods to compute PBP: There are two methods of calculating the PBP.
(a) The first method can be applied when the CFAT is uniform. In such a situation the initial cost of the nvestment is divided
by the constant annual cash flow: For example, if an investment of Rs. 100000 in a machine is expected to generate cash
inflow of Rs. 20,000 p.a. for 10 years. Its PBP will be calculated using following formula:
PBP=initial investment/constant annual cash inflow=100000/20000=5 year
(b) The second method is used when a projects CFAT are not equal. In such a situation PBP is calculated by the process of
cumulating CFAT till the time when cumulative cash flow becomes equal to the original investment outlays.For example, A
firm requires an initial cash outflow of Rs. 20,000 and the annual cash inflows for 5 years are Rs. 6000, Rs. 8000, Rs. 5000,
Rs. 4000 and Rs. 4000 respectively. Calculate PBP. Here, When we cumulate the cash flows for the first three years, Rs.
19,000 is recovered. In the fourth year Rs.4000 cash flow is generated by the project but we need to recover only Rs. 1000 so
the time required recovering Rs. 1000 will be (Rs.1000/Rs.4000) 12 months = 3 months. Thus, the PBP is 3 years and 3
months (3.25 years).
Decision Rule: The PBP can be used as a decision criterion to select investment proposal. If the PBP is less than the
maximum acceptable payback period, accept the project. If the PBP is greater than the maximum acceptable payback period,
reject the project.This technique can be used to compare actual pay back with a standard pay back set up by the management
in terms of the maximum period during which the initial investment must be recovered. The standard PBP is determined by
management subjectively on the basis of a number of factors such as the type of project, the perceived risk of the project etc.
PBP can be even used for ranking mutually exclusive projects. The projects may be ranked according to the length of PBP
and the project with the shortest PBP will be selected.
Merits: 1. It is simple both in concept and application and easy to calculate.
2. It is a cost effective method which does not require much of the time of finance executives as well as the use of computers.
3. It is a method for dealing with risk. It favours projects which generates substantial cash inflows in earlier years and
discriminates against projects which brings substantial inflows in later years . Thus PBP method is useful in weeding out risky
projects.
4. This is a method of liquidity. It emphasizes selecting a project with the early recovery of the investment.
Demerits: 1. It fails to consider the time value of money. Cash inflows, in pay back calculations, are simply added without
discounting. This violates the most basic principles of financial analysis that stipulates the cash flows occurring at different
points of time can be added or subtracted only after suitable compounding/ discounting.
2.2.2 Discounted Cash Flow Criteria:
These are also known as modern or time adjusted techniques because all these techniques take into consideration time value
of money.
(a) Net Present Value (NPV): The net present value is one of the discounted cash flow or time-adjusted technique. It
recognizes that cash flow streams at different time period differs in value and can be computed only when they are expressed
in terms of common denominator i.e. present value.
Meaning: The NPV is the difference between the present value of future cash inflows and the present value of the initial
outlay, discounted at the firms cost of capital. The procedure for determining the present values consists of two stages. The
first stage involves determination of an appropriate discount rate. With the discount rate so selected, the cash flow streams are
converted into present values in the second stage.
Method to compute NPV: 1. Cash flows of the investment project should be forecasted based on realistic assumptions. These
cash flows are the incremental cash inflow after taxes and are inclusive of depreciation (CFAT) which is assumed to be
received at the end of each year. CFAT should take into account salvage value and working capital released at the end.
2. Appropriate discount rate should be identified to discount the forecasted cash flows. The appropriate discount rate is the
firms opportunity cost of capital the forecasted cash flows. The appropriate discount rate is the firms opportunity cost of
capital which is equal to the required rate of return expected by investors on investments of equivalent risk.
3. Present value (PV) of cash flows should be calculated using opportunity cost of capital as the discount rate.
4. NPV should be found out by subtracting present value of cash outflows from present value of cash inflows. The project
should be accepted if NPV is
positive (i.e. NPV >0) The NPV can be calculated with the help of equation.
NPV = Present value of cash inflows Initial investment
Decision Rule: The present value method can be used as an accept-reject criterion. The present value of the future cash
streams or inflows would be compared with present value of outlays. The present value outlays are the same as the initial
investment. If the NPV is greater than 0, accept the project. If the NPV is less than 0, reject the project. Symbolically, accept-
reject criterion can be shown as below:
PV > C Accept [NPV > 0]
PV < C Reject [NPV < 0]
Where, PV is present value of inflows and C is the outlays.This method can be used to select between mutually exclusive
projects also. Using NPV the project with the highest positive NPV would be ranked first and that project would be selected.

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