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PROJECT APPRAISAL, PLANNING AND CONTROL

12MBAFM425

PROJECT APPRAISAL, PLANNING AND CONTROL 12MBAFM425 Module I (4 Hours) Planning & Analysis Overview: Phases of

Module I (4 Hours) Planning & Analysis Overview: Phases of capital budgeting Levels of decision making objective. Resource Allocation Framework: Key criteria for allocation of resource elementary investment strategies portfolio planning tools strategic position and action evaluation aspects relating to conglomerate diversification interface between strategic planning and capital budgeting.

Module II (6 Hours) Generation and screening of project ideas: Generation of ideas monitoring the environment regulatory framework for projects corporate appraisal preliminary screening project rating index sources of positive NPV qualities of a successful entrepreneur the porter model for estimation of profit potential of industries.

Market and demand analysis: Situational analysis and specification of objectives collection of secondary information conduct of market survey characterization of the market demand forecasting market planning. Technical analysis: Study of material inputs and utilities manufacturing process and technology product mixes plant capacity location and site machinery and equipment structures and civil works project charts and layouts work schedule

Module III (12 Hours) Financial Analysis: Estimation of cost of project and means of financing estimates of sales and production cost of production working capital requirement and its financing estimates of working results breakeven points projected cash flow statement projected balance sheet. Project cash flows: Basic principles of measurement of cash flows components of the cash flow streams viewing a project from different points of view definition of cash flows by financial institutions and planning commission biases in cash flow estimation. Appraisal criteria: Net Present Value benefit cost ratio internal rate of returns urgency payback period accounting rate of returns investment appraisal in practice.

urgency – payback period – accounting rate of returns – investment appraisal in practice. SJBIT/MBA Page
urgency – payback period – accounting rate of returns – investment appraisal in practice. SJBIT/MBA Page

PROJECT APPRAISAL, PLANNING AND CONTROL

12MBAFM425

PROJECT APPRAISAL, PLANNING AND CONTROL 12MBAFM425 Module IV (10 Hours) Types and measure of risk –

Module IV (10 Hours) Types and measure of risk simple estimation of risk sensitivity analysis scenario analysis montecarlo simulation decision tree analysis selection of project risk analysis in practice. Special decision situations: Choice between mutually exclusive projects of unequal life optimal timing decision determination of economic life inter-relationships between investment and financing aspects inflation and capital budgeting. Analysis of firm and market risk: Portfolio theory and capital budgeting capital asset pricing model estimation of key factors CAPM and Capital budgeting

Module V (5 Hours) Social Cost Benefit Analysis(SCBA): Rationale for SCBA UNIDO approach to SCBA Little and Mirle approach to SCBA.

Module VI (4 Hours) Multiple projects and constraints: Constraints methods of ranking mathematical programming approach linear programming model Qualitative Analysis: Qualitative factors in capital budgeting strategic aspects strategic planning and financial analysis informational asymmetry and capital budgeting organizational considerations. Environmental appraisal of projects: types and dimensions of a project meaning and scope of environment Environment Environmental resources values environmental impact assessment and environmental impact statement.

Module VII (5 Hours) Project financing in India: Means of finance norms and policies of financial institutions SEBI guidelines Sample financing plans structure of financial institutions in India schemes of assistance term loans procedures project appraisal by financial institutions.

Module VIII (10 Hours) Project Management: Forms of project organization project planning project control human aspects of project management prerequisites for successful project implementation.

– human aspects of project management – prerequisites for successful project implementation. SJBIT/MBA Page 2
– human aspects of project management – prerequisites for successful project implementation. SJBIT/MBA Page 2

PROJECT APPRAISAL, PLANNING AND CONTROL

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PROJECT APPRAISAL, PLANNING AND CONTROL 12MBAFM425 Network techniques for project management – development of

Network techniques for project management development of project network time estimation determination of critical path scheduling when resources are limit PERT and CPM models Network cost system (Only problems on resources allocation and resources leveling)

Project review and administrative aspects: Initial review performance evaluation abandonment analysis administrative aspects of capital budgeting evaluating the capital budgeting system of an organization.

Contents

Sl No:

Module

Page NO

1

Planning & Analysis Overview

4 - 16

2

Generation and screening of project ideas

17

- 28

3

Financial Analysis

29

- 36

4

Types and measure of risk

37

- 41

5

Social Cost Benefit Analysis(SCBA)

42

43

6

Multiple projects and constraints

44

56

7

Project financing in India

57

68

8

Project Management

69

77

56 7 Project financing in India 57 – 68 8 Project Management 69 – 77 SJBIT/MBA
56 7 Project financing in India 57 – 68 8 Project Management 69 – 77 SJBIT/MBA

PROJECT APPRAISAL, PLANNING AND CONTROL

12MBAFM425

PROJECT APPRAISAL, PLANNING AND CONTROL 12MBAFM425 Module I (4 Hours) Planning & Analysis Overview: Phases of

Module I (4 Hours) Planning & Analysis Overview: Phases of capital budgeting Levels of decision making objective. Resource Allocation Framework: Key criteria for allocation of resource elementary investment strategies portfolio planning tools strategic position and action evaluation aspects relating to conglomerate diversification interface between strategic planning and capital budgeting.

Capital Investment or Project “Capital Expenditure or capital Investment Involves a current outlay (or future outlay) of funds on the expectation of a stream of benefits extending far into the future”. PHASES OF CAPITAL BUDGETING Capital budgeting is a complex process that may be divided into six broad phases:

1. Planning

2. Analysis

3. Selection

4. Financing

5. Implementation

6. Review

Capital Budgeting Process

1. Planning 2. Analysis 3. Selection 4. Financing 5. Implementation 6. Review Capital Budgeting Process SJBIT/MBA
1. Planning 2. Analysis 3. Selection 4. Financing 5. Implementation 6. Review Capital Budgeting Process SJBIT/MBA
1. Planning 2. Analysis 3. Selection 4. Financing 5. Implementation 6. Review Capital Budgeting Process SJBIT/MBA

PROJECT APPRAISAL, PLANNING AND CONTROL

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PROJECT APPRAISAL, PLANNING AND CONTROL 12MBAFM425 1. Planning:  It is concerned with the articulation of

1. Planning:

It is concerned with the articulation of its broad investment strategy and the generation and preliminary screening of project proposals.

This provides the framework, which shapes, guides, and circumscribes the identification of individual project opportunities.

2. Analysis

If the preliminary screening suggests that the project is prima facie worthwhile, a detailed analysis of the marketing, technical, economic, and ecological aspects is undertaken.

The focus of this phase is on gathering, preparing, and summarizing relevant information about various project proposals, which are being considered for inclusion in the capital budget.

3. Selection

It addresses the question--- Is the project worthwhile? A wide range of appraisal criteria has been suggested to judge the worthwhile ness of a project.

They are divided into two broad categories, viz., non-discounting criteria (e.g. payback period and accounting rate of return) and discounting criteria (e.g. net present value, the internal rate of return)

4. Financing

Two broad sources of finance for a project are equity and debt. Equity consists of paid- up-capital, share premium and retaining earnings.

Debt consists of term loans, debentures and working capital advances.

Flexibility, risk, income, control and taxes are the key business considerations that influence the capital structure decision and the choice of specific instruments of financing.

that influence the capital structure decision and the choice of specific instruments of financing. SJBIT/MBA Page
that influence the capital structure decision and the choice of specific instruments of financing. SJBIT/MBA Page

PROJECT APPRAISAL, PLANNING AND CONTROL

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PROJECT APPRAISAL, PLANNING AND CONTROL 12MBAFM425 5. Implementation of several stages: (i) project and engineering

5. Implementation

of several stages: (i)

project and engineering designs, (ii) negotiations and contracting (iii) construction, (iv) training and (v) plant commissioning.

It

involves

setting up

of manufacturing facilities,

consists

6. Review

Performance review should be done periodically to compare actual performance with projected performance. A feedback device is useful in several ways: (i) it throws light on how realistic were the assumptions underlying the project; (ii) it provides a documented log of experience that is highly valuable in future decision-making; (iii) it suggests corrective action to be taken in the light of actual performance; (iv) it helps in uncovering judgmental biases; (v) it induces a desired caution among project sponsors.

Levels of Decision Making Gordon, Miller and Mintzberg defined three levels of decision making:operating, adminstrative and strategic decisions. The key characteristics of decisions at these levels as described below:

Characteristics

Operating

Administrative

Strategic

decisions

decisions

decisions

1. Level of decision

Lower level

Middle level

Top level

2. Structure of decision

Routine

Semi-structured

Unstructured

3. Level of resource commitment

Minor

Moderate

Major

4. Time Horizon

Short-term

Medium-term

Long-term

commitment Minor Moderate Major 4. Time Horizon Short-term Medium-term Long-term SJBIT/MBA Page 6
commitment Minor Moderate Major 4. Time Horizon Short-term Medium-term Long-term SJBIT/MBA Page 6

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PROJECT APPRAISAL, PLANNING AND CONTROL 12MBAFM425 Capital Allocation Capital is scarce and hence must be allocated

Capital Allocation Capital is scarce and hence must be allocated among competing claims very judiciously. The identification, evaluation and selection of individual investment proposals is usually guided by a

capital allocation framework, defined explicitly or implicitly by top mgt. The capital allocation framework of a firm spells out the kinds of businesses the firm wants to be in, the strategy of the firm. Key Criteria The following three key criteria we should see, before going to capital investment. They are:

1. Profitability

2. Risk

3. Growth

1. Profitability

is

It

the

principal

driving

force

for

business

activity.

relationship between profit and investment. Profit After Tax / Net worth

2. Risk

Profitability reflects

the

It reflects variability: How much do individual outcomes deviate from the expected value? A simple measure of variability is the range of possible outcomes, which is simply the difference between highest and lowest outcomes. 3. Growth Business firms actively pursue and achieve growth over a period of time. This is manifested in the increase of revenues, assets, net worth, profits, dividends and so on.

Elementary Investment Options The following are the elementary investment options:

1. Replacement & Modernization

2. Capacity expansion

3. Vertical Integration

4. Concentric diversification

5. Conglomerate diversification

6. Divestment

3. Vertical Integration 4. Concentric diversification 5. Conglomerate diversification 6. Divestment SJBIT/MBA Page 7
3. Vertical Integration 4. Concentric diversification 5. Conglomerate diversification 6. Divestment SJBIT/MBA Page 7

PROJECT APPRAISAL, PLANNING AND CONTROL

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PROJECT APPRAISAL, PLANNING AND CONTROL 12MBAFM425 1. Replacement & Modernization  It meant to maintain the

1. Replacement & Modernization

It meant to maintain the production capacity of the firm, improve quality and reduce costs.

Competitive strength of the firm will improve.

If such investments are neglected, the existence of firm in the market is difficult. Eg. Cotton Industry.

2. Capacity expansion

It will help to utilize full capacity or resources of a firm.

It will help to meet current demand of a firm and an increase in the market share.

Lower capital costs, familiarity with technology, production methods and market conditions reduction in unit overhead costs are the advantages of capacity expansion.

3. Vertical Integration

Vertical integration may be of two types:

(i) Backward integration and (ii) Forward integration

(i) Backward integration

It

involves

the manufacture of raw materials and components required for the

existing operations of the company.

(ii) Forward integration It involves the manufacture of products which use the existing products of the company as the input. Concentric Diversification

Adding of more

products

in

the

same

line

of

product

is

called

concentric

diversification. Eg. Hero Honda, Splendor, Splendor +, Passion, Super Splendor etc.

called concentric diversification. Eg. Hero Honda, Splendor, Splendor +, Passion, Super Splendor etc. SJBIT/MBA Page 8
called concentric diversification. Eg. Hero Honda, Splendor, Splendor +, Passion, Super Splendor etc. SJBIT/MBA Page 8

PROJECT APPRAISAL, PLANNING AND CONTROL

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PROJECT APPRAISAL, PLANNING AND CONTROL 12MBAFM425 5. Conglomerate Diversification It involves investment in fields

5. Conglomerate Diversification

It involves investment in fields unrelated to the existing line of business. Eg. L & T invests in Shipping

It overcomes the limited growth opportunities and reduces the overall risk exposure of the firm.

6.

Divestment

It is the opposite of the investment and involves termination or liquidation of the plant or a division of a firm. Reasons for divestment are low or negative profitability, declining market share, difficulty in managing etc.

Portfolio Planning Models To guide the process of strategic planning and resource allocation, several portfolio planning tools have been developed. Two such tools, highly relevant in the context of our present discussion are:

1. BCG Product Portfolio Matrix

2. General Electric‟s Stoplight Matrix

BCG Product Portfolio Matrix It is a tool for strategic (product) planning and resource allocation. The Boston Consulting Group (BCG) product portfolio matrix analyses products on the basis of (a) relative market share and (b) industry growth rate. The BCG matrix classifies products into four broad categories as follows:

BCG Product Portfolio Matrix

 

High

Low

High

Stars

Question

Marks

Low

Cash

Dogs

Cows

Matrix   High Low High Stars Question Marks Low Cash Dogs Cows SJBIT/MBA Page 9
Matrix   High Low High Stars Question Marks Low Cash Dogs Cows SJBIT/MBA Page 9

PROJECT APPRAISAL, PLANNING AND CONTROL

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PROJECT APPRAISAL, PLANNING AND CONTROL 12MBAFM425 1. Stars: Products which enjoy a high market share and

1. Stars:

Products which enjoy a high market share and a high growth rate are referred to as stars. Though they earn high profits, they require additional commitment of funds because of

the need to make further investments for expanding their production and sales.

2. Question Marks:

Products with high growth potential but low present market share are called question

marks. Additional resources are required to improve their market share and potentially convert them into stars. Of course, their is no guarantee that this would happen.

3. Cash cows:

Products which enjoy a relatively high market share but low growth potential are called cash cows. The generate substantial profits and cash flows but their investment requirements are

modest. 4. Dogs:

Products with low market share and limited growth potential are referred to as dogs. Since the prospects for such products are bleak, it is advisable to phase them out rather than continue with them. From the above description, it is broadly clear that cash cows generate funds and dogs if divested, release funds. Stars and question marks require further commitment of funds.

II. General Electric’s Stoplight Matrix The General Electric Company of US developed a matrix for guiding resource allocation is called the General Electric‟s Stoplight Matrix. It describes various products or services or the firm in terms of two key issues.

Stoplight Matrix. It describes various products or services or the firm in terms of two key
Stoplight Matrix. It describes various products or services or the firm in terms of two key

PROJECT APPRAISAL, PLANNING AND CONTROL

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General Electric’s Stoplight Matrix

AND CONTROL 12MBAFM425 General Electric’s Stoplight Matrix Industry Attractiveness Business Strength 1. Business

Industry

Attractiveness

Business Strength

Stoplight Matrix Industry Attractiveness Business Strength 1. Business Strength: How strong is the firm vis-à-vis its

1. Business Strength: How strong is the firm vis-à-vis its competitors? 2. Industry Attractiveness: What is the attractiveness or potential of the industry?

The commitment of funds to various products is guided by how they are rated In terms of the above two dimensions. Products which are favorably placed call for divestment and products which are placed in between qualify for modest investment.

STRATEGIC POSITION AND ACTION EVALUATION (SPACE) SPACE is an approach to hammer out an appropriate strategic posture for a firm and its individual businesses. SPACE involves a consideration of four dimensions:

1. Company‟s competitive advantage

2. Company‟s financial strength

3. Industry strength

1. Company‟s competitive advantage 2. Company‟s financial strength 3. Industry strength SJBIT/MBA Page 11
1. Company‟s competitive advantage 2. Company‟s financial strength 3. Industry strength SJBIT/MBA Page 11

PROJECT APPRAISAL, PLANNING AND CONTROL

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PROJECT APPRAISAL, PLANNING AND CONTROL 12MBAFM425 4. Environmental stability The factors determining competitive

4.

Environmental stability

The factors determining competitive advantage, financial strength, industry strength and environmental stability are shown as follows:

advantage, financial strength, industry strength and environmental stability are shown as follows: SJBIT/MBA Page 12
advantage, financial strength, industry strength and environmental stability are shown as follows: SJBIT/MBA Page 12
advantage, financial strength, industry strength and environmental stability are shown as follows: SJBIT/MBA Page 12
advantage, financial strength, industry strength and environmental stability are shown as follows: SJBIT/MBA Page 12
PROJECT APPRAISAL, PLANNING AND CONTROL 12MBAFM425
PROJECT APPRAISAL, PLANNING AND CONTROL
12MBAFM425
PROJECT APPRAISAL, PLANNING AND CONTROL 12MBAFM425 Strategic Planning & Capital Budgeting Capital expenditures,
PROJECT APPRAISAL, PLANNING AND CONTROL 12MBAFM425 Strategic Planning & Capital Budgeting Capital expenditures,

Strategic Planning & Capital Budgeting Capital expenditures, particularly the major ones, are supposed to sub serve the strategy of the firm. Hence, the relationship between strategic planning and capital budgeting must be properly recognized. Capital budgeting may be viewed as a two-stage process. In the first stage promising growth opportunities are identified through the use of strategic planning techniques and in the second stage individual investment proposals are analyzed and evaluated in detail to determine their worthiness. Strategy involves matching a firm‟s „strengths‟ and „weaknesses‟– its distinctive competencies with the „opportunities‟ and „threats‟ present in the external environment.

Facets of Project Analysis

„opportunities‟ and „threats‟ present in the external environment. Facets of Project Analysis SJBIT/MBA Page 13
„opportunities‟ and „threats‟ present in the external environment. Facets of Project Analysis SJBIT/MBA Page 13

PROJECT APPRAISAL, PLANNING AND CONTROL

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PROJECT APPRAISAL, PLANNING AND CONTROL 12MBAFM425 The important facets of project analysis are: 1. Market Analysis
PROJECT APPRAISAL, PLANNING AND CONTROL 12MBAFM425 The important facets of project analysis are: 1. Market Analysis

The important facets of project analysis are:

1. Market Analysis

2. Technical Analysis

3. Financial Analysis

4. Economic Analysis

5. Ecological Analysis

1.Market Analysis

Market analysis is concerned primarily with two questions:

1. What would be the aggregate demand of the proposed product/service in the future?

2. What would be the market share of the project under appraisal? To answer the above questions, the following information required are:

Consumption trends in the past and the present consumption level.

Past and present supply position

Production possibilities and constraints

Imports and exports

Structure of competition

Cost Structure

Elasticity of demand

Distribution channels and marketing policies in use

Consumer behaviour, intentions, motivations, attitudes, preferences and requirements

Administrative, technical and legal constraints.

attitudes, preferences and requirements • Administrative, technical and legal constraints. SJBIT/MBA Page 14
attitudes, preferences and requirements • Administrative, technical and legal constraints. SJBIT/MBA Page 14

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PROJECT APPRAISAL, PLANNING AND CONTROL 12MBAFM425 2 . Technical Analysis Technical analysis seeks to determine whether

2. Technical Analysis Technical analysis seeks to determine whether the prerequisites for the successful commissioning of the project have been considered and reasonably good choices have been

to location, size, process, etc. The important questions raised in technical

make with respect analysis are:

Whether the preliminary tests and studies have been done or provided for?

Whether the availability of raw materials, power, and other inputs has been established?

Whether the selected scale of operation is optimal?

Whether the auxiliary equipments and supplementary engineering works have been provided for?

Whether the proposed layout of the site, buildings and plant is sound?

Whether work schedule have been realistically drawn up?

Whether the technology proposed to be employed is appropriate from the social point of view?

3. Financial Analysis Financial analysis seeks to ascertain whether the proposed project will be financially

viable and weather the proposed project will satisfy the return expectations of those who provide the capital. The following aspects have to be seen in financial analysis are:

Investment outlay and cost of project

Means of financing

Cost of capital

Projected profitability

Break-even point

Cash flows of the project

Investment worthwhileness judged in terms of various criteria of merit

Projected financial position

Level of risk

4. Economic Analysis

Economic analysis, also referred to as social cost benefit analysis, is concerned with judging a project from the larger social point of view. The questions sought to be answered

in social cost benefit analysis are:

larger social point of view. The questions sought to be answered in social cost benefit analysis
larger social point of view. The questions sought to be answered in social cost benefit analysis

PROJECT APPRAISAL, PLANNING AND CONTROL

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PROJECT APPRAISAL, PLANNING AND CONTROL 12MBAFM425 • What are the direct economic benefits and costs of

What are the direct economic benefits and costs of the project measured in terms of shadow(efficiency) prices and not in terms of market prices?

What would be impact of the project on the distribution of income in the society?

What would be the impact of the project on the level of savings and investment in the society?

What would be the contribution of the project towards the fulfillment of certain merit wants like self-sufficiency, employment and social order? 5. Ecological Analysis Ecological Analysis should be done particularly for major projects which have

significant ecological implications (like power plants and irrigation schemes) and environment- polluting industries (like bulk drugs, chemicals, and leather processing). The key questions raised in ecological analysis are:

What is the likely damage caused by the project to the environment?

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

measures required to ensure that the damage to the environment is contained within acceptable limits? SJBIT/MBA
measures required to ensure that the damage to the environment is contained within acceptable limits? SJBIT/MBA

PROJECT APPRAISAL, PLANNING AND CONTROL

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PROJECT APPRAISAL, PLANNING AND CONTROL 12MBAFM425 Module II (6 Hours) Generation and screening of project ideas

Module II (6 Hours) Generation and screening of project ideas: Generation of ideas monitoring the environment regulatory framework for projects corporate appraisal preliminary screening project rating index sources of positive NPV qualities of a successful entrepreneur the porter model for estimation of profit potential of industries.

Market and demand analysis: Situational analysis and specification of objectives collection of secondary information conduct of market survey characterization of the market demand forecasting market planning. Technical analysis: Study of material inputs and utilities manufacturing process and technology product mixes plant capacity location and site machinery and equipment structures and civil works project charts and layouts work schedule

Stimulating the flow of Ideas 1.SWOT Analysis 2.Clear Articulation of Objectives 3.Fostering a Conducive Climate

SWOT Analysis

Strengths

Weaknesses

Opportunities

Threats

An OPPORTUNITY is a chance for firm growth or progress due to a favorable juncture of circumstances in the business environment.

Possible Opportunities:

Emerging customer needs

Quality Improvements

environment.  Possible Opportunities:  Emerging customer needs  Quality Improvements SJBIT/MBA Page 17
environment.  Possible Opportunities:  Emerging customer needs  Quality Improvements SJBIT/MBA Page 17

PROJECT APPRAISAL, PLANNING AND CONTROL

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PROJECT APPRAISAL, PLANNING AND CONTROL 12MBAFM425  Expanding global markets  Vertical Integration  A THREAT

Expanding global markets

Vertical Integration

A THREAT is a factor in your company‟s external environment that poses a danger to its

well-being.

Possible Threats:

New entry by competitors

Changing demographics/shifting demand

Emergence

Regulatory requirements

of cheaper technologies

By examining opportunities, you can discover untapped markets, and new products or technologies, or identify potential avenues for diversification.

By examining threats, you can identify unfavorable market shifts or changes in

technology, and create a defensive posture aimed at preserving your competitive position. The purpose of SWOT Analysis It is an easy- to-use tool for developing an overview of a company‟s strategic situation. It

forms a basis for matching your company‟s strategy to its situation.

It

identify opportunities that can be profitably exploited by it

provides

the “raw material” to do more extensive internal and external analysis and

Clear Articulation of Objectives

Cost reduction

Increase in capacity utilization

Improvement in contribution margin

Expansion into promising fields

Monitoring the environment

Economic sector

Government Sector

Technological Sector

Socio-Demographic Sector

Competition Sector

 Government Sector  Technological Sector  Socio-Demographic Sector  Competition Sector SJBIT/MBA Page 18
 Government Sector  Technological Sector  Socio-Demographic Sector  Competition Sector SJBIT/MBA Page 18

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PROJECT APPRAISAL, PLANNING AND CONTROL 12MBAFM425  Supplier Sector Corporate Appraisal  Marketing &

Supplier Sector

PLANNING AND CONTROL 12MBAFM425  Supplier Sector Corporate Appraisal  Marketing & Distribution 

Corporate Appraisal

Marketing & Distribution

Production & Operations

Research & Development

Corporate resources & personnel

Finance & Accounting

Preliminary Screening

1. Compatibility with the promoter

2. Consistency with governmental priorities

3. Availability of inputs

4. Adequacy of market

5. Reasonableness of cost

6. Acceptability of risk level

Project Rating Index Steps in Project Rating Index

1. Identify factors relevant for project rating.

2. Assign weights to these factors according to importance

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

according to importance 3. Rate the project proposal on various factors using a suitable rating scale.
according to importance 3. Rate the project proposal on various factors using a suitable rating scale.

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PROJECT APPRAISAL, PLANNING AND CONTROL 12MBAFM425 4. For each factor, multiply the factor rating with the

4. For each factor, multiply the factor rating with the factor weight to get the factor score.

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

Sources of Positive Net Present Value

Entry barriers that result in positive NPV projects:

1. Economies of Scale Economies of scale means that an increase in the scale of production, marketing or

distribution results in a decline in the cost per unit.

In order to exploit the economies of scale new entrants require a substantial investment in

plant & machinery, research & development and market development. The greater the capital requirement, the higher the barrier to entry. Eg. Petroleum Refining, Mineral extraction, iron & steel industry etc.

2. Product Differentiation A firm can create an entry barrier by successfully differentiating its products from

those of its rivals. The basic differentiation is

Effective advertising and superior marketing

Exceptional service.

Innovative product features

High quality & dependability

3. Cost Advantage

If a firm can enjoy cost advantage vis-à-vis its competitors, it can be reasonable assured

of earning superior returns.

E.g

Low material cost, cheep labour , a favourable location etc.

4. Marketing Reach

A penetrating marketing reach is an important source of competitive advantage. E.g

The

breadth and debth of Hindustan Lever‟s distribution network is larger than its competitors.

E.g The breadth and debth of Hindustan Lever‟s distribution network is larger than its competitors. SJBIT/MBA
E.g The breadth and debth of Hindustan Lever‟s distribution network is larger than its competitors. SJBIT/MBA

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PROJECT APPRAISAL, PLANNING AND CONTROL 12MBAFM425 5. Technological Edge Technological superiority enable a firm to

5. Technological Edge

Technological superiority enable a firm to enjoy excellent returns. Eg. IBM, Xerox, Dr. Reddy‟s Laboratory & Hero Honda etc.

6. Govt. Policy Govt. policies that create entry barriers, partial or absolute, include the following:

Restrictive Licensing

Import restrictions

High tariff

Environmental Controls

Special tax relieves.

Qualities of a successful entrepreneur

A successful entrepreneur has the following qualities and traits:

1. Willingness to make sacrifices

2. Leadership

3. Decisiveness

4. Confidence in the project

5. Marketing orientation

6. Strong ego

Profit Potential of Industries Porter Model Micheal Porter has argued that the profit potential of an industry depends on the combined strength of the following five basic competitive forces:

of an industry depends on the combined strength of the following five basic competitive forces: SJBIT/MBA
of an industry depends on the combined strength of the following five basic competitive forces: SJBIT/MBA

PROJECT APPRAISAL, PLANNING AND CONTROL

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PROJECT APPRAISAL, PLANNING AND CONTROL 12MBAFM425  The five forces are environmental forces that impact on
PROJECT APPRAISAL, PLANNING AND CONTROL 12MBAFM425  The five forces are environmental forces that impact on

The five forces are environmental forces that impact on a company‟s ability to compete in a given market.

The purpose of five-forces analysis is to diagnose the principal competitive pressures in a market and assess how strong and important each one is.

Barriers to Entry

a. Economies of Scale

b. Product Differentiation

c. Capital Requirements

d. Switching Costs

e. Access to Distribution Channels

f. Cost Disadvantages Independent of Scale

g. Government Policy

h. Expected Retaliation

Bargaining Power of Suppliers

Suppliers are likely to be powerful if:

a. Supplier industry is dominated by a few firms

b. Suppliers‟ products have few substitutes

c. Buyer is not an important customer to supplier

firms b. Suppliers‟ products have few substitutes c. Buyer is not an important customer to supplier
firms b. Suppliers‟ products have few substitutes c. Buyer is not an important customer to supplier

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PROJECT APPRAISAL, PLANNING AND CONTROL 12MBAFM425 d. Suppliers‟ product is an important input to buyers‟ product

d. Suppliers‟ product is an important input to buyers‟ product

e. Suppliers‟ products are differentiated

f. Suppliers‟ products have high switching costs

g. Supplier poses credible threat of forward integration

Bargaining Power of Buyers

a. Buyer groups are likely to be powerful if:

b. Buyers are concentrated or purchases are large relative to seller‟s sales

c. Purchase accounts for a significant fraction of supplier‟s sales

d. Products are undifferentiated

e. Buyers face few switching costs

f. Buyers‟ industry earns low profits

g. Buyer presents a credible threat of backward integration

h. Product unimportant to quality

i. Buyer has full information

Threat of Substitute Products Keys to evaluate substitute products:

Products with improving price/performance tradeoffs relative to present industry products

examples:

Electronic security systems in place of security guards

Fax machines in place of overnight mail delivery

Rivalry Among Existing Competitors

a. Intense rivalry often plays out in the following ways:

b. Jockeying for strategic position

c. Using price competition

d. Staging advertising battles

e. Increasing consumer warranties or service

f. Making new product introductions

Occurs when a firm is pressured or sees an opportunity

a. Price competition often leaves the entire industry worse off

b. Advertising battles may increase total industry demand, but may be costly to smaller competitors

b. Advertising battles may increase total industry demand, but may be costly to smaller competitors SJBIT/MBA
b. Advertising battles may increase total industry demand, but may be costly to smaller competitors SJBIT/MBA

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PROJECT APPRAISAL, PLANNING AND CONTROL 12MBAFM425 c. Numerous or equally balanced competitors d. Slow growth industry

c. Numerous or equally balanced competitors

d. Slow growth industry

e. High fixed costs

f. High storage costs

g. Lack of differentiation or switching costs

h. Capacity added in large increments

i. Diverse competitors

j. High strategic stakes

k. High exit barriers

Technical Analysis

Broad purpose of technical analysis is

(a) To ensure that the project is technically feasible in the sense that all the inputs required to set up the project are available and (b) To facilitate the most optimal formulation of the project in terms of technology, size, location and so on. Manufacturing Process & Technology For manufacturing a product or service, two or more alternative technologies are available. For example,

Cement can be made either by the dry process or the wet process.

Soda can be made by the electrolysis method or the chemical method.

Soap can be manufactured by the semi-boiled process or the fully boiled process.

Choice of Technology The choice of technology is influenced by a variety of considerations:

Plant Capacity

Availability of Principal inputs

Investment Outlay and Production Costs

Use by other units

Product mix

Latest Development

Ease of Absorption

Costs  Use by other units  Product mix  Latest Development  Ease of Absorption
Costs  Use by other units  Product mix  Latest Development  Ease of Absorption

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PROJECT APPRAISAL, PLANNING AND CONTROL 12MBAFM425 Appropriateness of Technology Appropriate technology refers to those

Appropriateness of Technology Appropriate technology refers to those methods of production which are suitable to local economic, social and cultural conditions. Example:

Whether it utilizes local raw materials & local man power? Whether it is harmonious with social & cultural conditions?

Material Inputs & Utilities

1. Raw materials (i) Agricultural products (E.g:Sugar-cane for producing papers)

(ii) Mineral products

(iii)

Livestock and Forest Products

(iv)

Marine products (Eg. Coral, fish oil-ornaments, food, medicine etc.)

2. Processed Industrial Materials and Components

3. Auxiliary Materials and Factory Supplies

4. Utilities

Product Mix

Product mix is the collection of products. In the production of most of the items, variations in size and quality are aimed at satisfying a broad range of customers.

For example, a garment manufacturer may have a wide range in terms of size and quality to cater to different customers. The variation in quality can enable

Plant Capacity Plant capacity (also referred to as production capacity) refers to the volume or no. of units that can be manufactured during a given period.

and

Nominal maximum capacity (NMC) (I) The feasible normal capacity refers to the capacity attainable under normal working conditions.

Plant

capacity

can be

defined

in two

ways: (I)

feasible

normal capacity(FNC)

working conditions. Plant capacity can be defined in two ways: (I) feasible normal capacity(FNC) SJBIT/MBA Page
working conditions. Plant capacity can be defined in two ways: (I) feasible normal capacity(FNC) SJBIT/MBA Page

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PROJECT APPRAISAL, PLANNING AND CONTROL 12MBAFM425 (II) The nominal maximum capacity is the capacity which is

(II) The nominal maximum capacity is the capacity which is technically attainable and is installed capacity guaranteed by the supplier of the plant.

Plant Capacity Decision Factors The following factors will decide the plant capacity:

Technological requirement

Input constraints

Investment cost

Market conditions

Resources of the firm

Govt. Policy

Location & Site Location refers to a fairly broad area, like a city, industrial area or coastal area. Site refers to a specific piece of land where the project would be set up. The choice of location is influenced by a variety of factors. They are:

Proximity to Raw materials & Markets

Availability of infrastructure

Labour Situation

Governmental Policies

Other factors

Machineries & Equipment

It is dependent on production technology and plant capacity.

Type of project.

Procedure for determining kind of machineries & equipment

Estimate the likely levels of production overtime.

Define the various machining and other operations.

Calculate the machine hours required for each type of operation.

Select machineries and equipments required for each function

required for each type of operation.  Select machineries and equipments required for each function SJBIT/MBA
required for each type of operation.  Select machineries and equipments required for each function SJBIT/MBA

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PROJECT APPRAISAL, PLANNING AND CONTROL 12MBAFM425 Classification of Equipment required for project  Plant (process)

Classification of Equipment required for project

Plant (process) equipments.

Mechanical equipments.

Electrical equipments.

Instruments.

Internal transportation system.

Constraints in Selecting Machineries & Equipment

Limited availability of power.

Difficulty in transporting a heavy equipments.

Workers may not be able to operate, at least in the initial stage.

Import policy of the Government.

Procurement of Plant & Machinery Orders for different items of plant and machinery may be placed with different suppliers or a turnkey contract may be given for the entire plant and machinery to a single supplier. Factors in selecting the suppliers:

1. Desired quality of machinery.

2. Level of technology.

3. Reputation of various suppliers.

4. Expected delivery schedules.

5. Preferred payment terms.

6. Required performance guarantees.

Structures & Civil Works

1. Site Preparation and Development

2. Building & Structures

3. Outdoor works

Project Charts & Layouts

1. General Functional Layout

Building & Structures 3. Outdoor works Project Charts & Layouts 1. General Functional Layout SJBIT/MBA Page
Building & Structures 3. Outdoor works Project Charts & Layouts 1. General Functional Layout SJBIT/MBA Page

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PROJECT APPRAISAL, PLANNING AND CONTROL 12MBAFM425 2. Material Flow Diagram 3. Production line Diagrams 4. Transport

2. Material Flow Diagram

3. Production line Diagrams

4. Transport Layout

5. Utility Consumption Layout

6. Communication Layout

7. Organizational Layout

8. Plant Layout

Work Schedule

It reflects the plan of work concerning installation as well as initial operation.

Purpose of Work Schedule:

To anticipate problems likely to arise during the installation phase and suggest possible means for coping with them.

To establish the phasing of investments taking in to account the availability of finances.

To develop a plan of operations covering the initial period.

the availability of finances.  To develop a plan of operations covering the initial period. SJBIT/MBA
the availability of finances.  To develop a plan of operations covering the initial period. SJBIT/MBA

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PROJECT APPRAISAL, PLANNING AND CONTROL 12MBAFM425 Module III (12 Hours) Financial Analysis : Estimation of cost

Module III (12 Hours) Financial Analysis: Estimation of cost of project and means of financing estimates of sales and production cost of production working capital requirement and its financing estimates of working results breakeven points projected cash flow statement projected balance sheet. Project cash flows: Basic principles of measurement of cash flows components of the cash flow streams viewing a project from different points of view definition of cash flows by financial institutions and planning commission biases in cash flow estimation. Appraisal criteria: Net Present Value benefit cost ratio internal rate of returns urgency payback period accounting rate of returns investment appraisal in practice.

Cost of Project

The cost of project represents the total of all items of outlay (or expenses) associated with a project which are supported by long-term funds. It is sum of the outlays on the following:

1. Land & Site Development.

2. Buildings & Civil works.

3. Plant & Machinery.

4. Technical know-how and Engineering Fees

5. Expenses on Foreign Technicians and Training of Indian Technicians Abroad.

6. Miscellaneous Fixed Assets.

7. Preliminary & Capital issue expenses.

8. Pre-operative expenses.

9. Provision for contingencies.

10. Margin money for working capital.

11. Initial cash losses.

Means of Finance

1. Share capital.

2. Term loans.

3. Debenture capital.

4. Deferred credit.

losses. Means of Finance 1. Share capital. 2. Term loans. 3. Debenture capital. 4. Deferred credit.
losses. Means of Finance 1. Share capital. 2. Term loans. 3. Debenture capital. 4. Deferred credit.

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PROJECT APPRAISAL, PLANNING AND CONTROL 12MBAFM425 5. Incentive sources. 6. Miscellaneous sources. Key business

5. Incentive sources.

6. Miscellaneous sources.

Key business consideration in means of finance

1. Cost

2. Risk

3. Control

4. Flexibility

Estimates of Sales & Production

It is not advisable to assume a high capacity utilization level in the first year of operations.

It is sensible to assume that capacity utilization would be somewhat low in the first year and rise thereafter gradually to reach maximum capacity.

It is not necessarily to make adjustments for stocks of finished goods. For practical purposes, it may be assumed that production would be equal to sales.

The selling price will vary according to variations in the cost of production.

Cost of Production

1. Material cost

2. Utilities cost

3. Labour cost

4. Factory O/H cost

Working Capital Requirements & Its Financing

1. Working capital requirements.

2. Sources of Working Capital Finance.

3. Limits to obtaining working capital advances

4. Raw materials and components.

5. Stock of goods- in-process.

6. Stocks of finished goods.

7. Debtors.

8. Operating expenses.

5. Stock of goods- in-process. 6. Stocks of finished goods. 7. Debtors. 8. Operating expenses. SJBIT/MBA
5. Stock of goods- in-process. 6. Stocks of finished goods. 7. Debtors. 8. Operating expenses. SJBIT/MBA

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PROJECT APPRAISAL, PLANNING AND CONTROL 12MBAFM425 Sources of Working Capital Finance • Working capital advances

Sources of Working Capital Finance

Working capital advances provided by commercial banks.

Trade-credit.

Accruals and provisions. Long term sources of financing

Limits to obtaining working capital advances

The aggregate permissible bank finance is specified as per the norms of lending prescribed by the Tandon Committee.

Against each current asset a certain amount of margin money has to be provided by the firm. Estimates of working results (Or) Profitability Projections

A. Cost of Production.

B. Total Administrative expenses.

C. Total sales expenses.

D. Royalty and Know-how payable.

E. Total cost of production. {A+B+C+D=E}

F. Expected sales.

G. Gross profit before interest. {F - E}

H. Total financial expenses.

I. Depreciation.

J. Operating Profit. {G H - I}

K. Other income

L. Preliminary expenses written off.

M. Profit/ Loss before taxation. {J + K - L}

N. Provision for Taxation.

O. Profit after tax {M - N} Less: Dividend on -- Preference capital.

K - L} N. Provision for Taxation. O. Profit after tax {M - N} Less: Dividend
K - L} N. Provision for Taxation. O. Profit after tax {M - N} Less: Dividend

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PROJECT APPRAISAL, PLANNING AND CONTROL 12MBAFM425 -- Equity capital. P. Retained Profit. Q. Net cash accrual.

-- Equity capital. P. Retained Profit. Q. Net cash accrual. {P + I + L}

Break Even Point

It refers to the level of operation at which the project neither makes profit nor incurs loss is calculated.

Cost has to be divided in two parts i.e. Fixed cost and variable cost.

B.E.P. = Fixed Costs

Unit selling price -- Unit Variable cost Cash Flow Statement Cash flow statement shows the movement of cash into and out of the firm and its net impact on the cash balance within the firm.

Projected Cash Flow Statements

cash balance within the firm. Projected Cash Flow Statements Projected Balance Sheet The balance sheet, showing

Projected Balance Sheet The balance sheet, showing the balance in various asset and liability accounts, reflects the financial condition of the firm at a given point of time.

asset and liability accounts, reflects the financial condition of the firm at a given point of
asset and liability accounts, reflects the financial condition of the firm at a given point of

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PROJECT APPRAISAL, PLANNING AND CONTROL 12MBAFM425 Cash Flow Whatever cash come within the firm and go
PROJECT APPRAISAL, PLANNING AND CONTROL 12MBAFM425 Cash Flow Whatever cash come within the firm and go

Cash Flow Whatever cash come within the firm and go out of the firm during the project period is called project cash flow. Elements of the Cash Flow Stream The cash flow stream of a project comprises three basic components (I) initial investment (ii) Operating cash inflows and (iii) terminal cash inflow.

Time Horizon for Analysis

1. Physical Life of the plant

2. Technological life of the plant

3. Product market life of the plant

4. Investment planning horizon of the firm

5. Separation Principle

6. Incremental Principle

7. Post tax Principle

8. Consistency Principle

Viewing a Project from Different Points of View Financial Institutions In evaluating project proposals submitted to them, financial institutions define project cash flows as follows:

Initial Cash outflow:

Capital expenditure on the project + outlays on W.C Operating inflow: Profit after tax +Depn. +Int. and lease rentals

on the project + outlays on W.C Operating inflow: Profit after tax +Depn. +Int. and lease
on the project + outlays on W.C Operating inflow: Profit after tax +Depn. +Int. and lease

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PROJECT APPRAISAL, PLANNING AND CONTROL 12MBAFM425 Terminal inflow: Recovery of working capital (at book value) +

Terminal inflow: Recovery of working capital (at book value) + Residual value of capital assets (land at 100% and other capital assets at 5% on initial cost

For calculating IRR the cash flows are considered for a maximum project life of 12 years. For certain industries, which are subject to a faster rate of technological obsolescence, a shorter life is considered. Definition of Cash Flow by Planning Commission As per the Manual for Preparation of Feasibility Reports developed by the Planning Commission, the following rules should be observed in defining costs and returns (cash flows):

1. Interest during construction should not be allowed for in the year-wise capital expenditure figures since it is implicitly taken into account by the discounting procedure.

2. Returns should be defined on a gross basis as operating revenues minus operating costs. Depn.and financial charges on capital expenditures covered by the capital cost figures should not be deducted in defining returns.

3. Capital cost estimates generally do not allow for funds required for working capital

purposes, which are assumed to be borrowed, but only for the margin on working capital. In this case the operating cost estimates must include interest payments on funds borrowed for working capital.

4. 4. In some cases involving the use of fixed-interest term loans for capital expenditure, an internal rate of return on own funds (equity) may need to be presented. In such cases the initial capital cost figures should cover only the expenditure out of equity capital.

5. 5. Costs and returns should be calculated over the entire life

of the project or over 25

yrs.whichever is less. The return should allow for a salvage value of assets at the end of the period.

Observations based on the above description are as follows:

1. A project may be viewed for the point of view of equity capital or long-term funds.

2. Cost and return stream have been defined consistently with the point of view adopted. They are defined in pre-tax terms.

3. A fairly long planning horizon is envisaged. This perhaps reflects the fact that the projects considered by the Planning Commission, in general, have a long economic life.

fact that the projects considered by the Planning Commission, in general, have a long economic life.
fact that the projects considered by the Planning Commission, in general, have a long economic life.

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PROJECT APPRAISAL, PLANNING AND CONTROL 12MBAFM425 Biases in Cash-flow Estimation I. Overstatement of Profitability In

Biases in Cash-flow Estimation

I. Overstatement of Profitability

In forecasting the outcomes of risky projects, executives often commit planning fallacy, implying that they display over optimism.

Native Optimism

Attribution error

Anchoring

Competitor neglect

Organisation pressure

Stretch targets

II. Understatement of Profitability

There can be an opposite kind of bias relating to the understatement of profitability which may depress a project‟s true profitability.

Salvage Values are Under-estimated

Intangible benefits are ignored

The value of future options is overlooked

Types of Investment Decisions

One classification is as follows:

Expansion of existing business

Expansion of new business

Replacement and modernisation

Yet another useful way to classify investments is as follows:

Mutually exclusive investments

Independent investments

Contingent investments

Investment Evaluation Criteria

Three steps are involved in the evaluation of an investment:

Estimation of cash flows

Estimation of the required rate of return (the opportunity cost of capital)

of cash flows – Estimation of the required rate of return (the opportunity cost of capital)
of cash flows – Estimation of the required rate of return (the opportunity cost of capital)

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PROJECT APPRAISAL, PLANNING AND CONTROL 12MBAFM425 – Application of a decision rule for making the choice

Application of a decision rule for making the choice Evaluation Criteria

1. Discounted Cash Flow (DCF) Criteria

Net Present Value (NPV)

Internal Rate of Return (IRR)

Profitability Index (PI)

2. Non-discounted Cash Flow Criteria

Payback Period (PB)

Discounted Payback Period (DPB)

Accounting Rate of Return (ARR)

– Payback Period (PB) – Discounted Payback Period (DPB) – Accounting Rate of Return (ARR) SJBIT/MBA
– Payback Period (PB) – Discounted Payback Period (DPB) – Accounting Rate of Return (ARR) SJBIT/MBA

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PROJECT APPRAISAL, PLANNING AND CONTROL 12MBAFM425 Module IV (10 Hours) Types and measure of risk –

Module IV (10 Hours)

Types and measure of risk simple estimation of risk sensitivity analysis scenario analysis montecarlo simulation decision tree analysis selection of project risk analysis in practice. Special decision situations: Choice between mutually exclusive projects of unequal life optimal timing decision determination of economic life inter-relationships between investment and financing aspects inflation and capital budgeting. Analysis of firm and market risk: Portfolio theory and capital budgeting capital asset pricing model estimation of key factors CAPM and Capital budgeting

Analysis of Risk Risk analysis is one of the most complex and slippery aspects of capital budgeting. Many different techniques have been suggested and no singe technique can be deemed as best in all situations.

Types of Project Risk

Stand alone Risk. {Isolation}

Firm Risk. {Corporate risk}

Systematic risk. {Market risk}

Sources of Risk

Project-specific risk: The earnings and cash flows of the project may be lower than expected because of estimation error or due to some other factors specific to the project like the quality of mgt.

Competitive risk: The earnings and cash flows of the project may be affected by unanticipated actions of the competitors.

Industry specific risk: Unexpected technological developments and regulatory changes, that are specific to the industry to which the project belongs, will have an impact on the earnings and cash flows of the project as well.

which the project belongs, will have an impact on the earnings and cash flows of the
which the project belongs, will have an impact on the earnings and cash flows of the

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PROJECT APPRAISAL, PLANNING AND CONTROL 12MBAFM425  Market risk: Unanticipated changes in macroeconomic factors

Market risk: Unanticipated changes in macroeconomic factors like the GDP growth rate, interest rate, and inflation have an impact on all projects.

International risk: In the case of a foreign project, the earnings and cash flows may be different than expected due to the exchange rate risk or political risk

Measures of Risk

Range.

Mean absolute deviation.

Standard deviation.

Coefficient of variation.

Semi-variance.

Analytical Derivation or Simple estimation

No correlation among cash flows.

Perfect correlation among cash flows.

Moderate correlation among cash flows.

Sensitivity Analysis

Sometimes called ‟What if‟ analysis

One one variable is varied at a time.

Example:

“what will happen to NPV if sales are only 50,000 units rather than the expected 75,000

units?”

Procedure

Setup the relationship between the basic underlying factors (quantity sold or unit selling price) and NPV.

Estimate the Range of variation and the most likely value of each of the basic underlying factors.

Study the effect on net present value of variations in the basic variables.

underlying factors. • Study the effect on net present value of variations in the basic variables.
underlying factors. • Study the effect on net present value of variations in the basic variables.

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PROJECT APPRAISAL, PLANNING AND CONTROL 12MBAFM425 Merits of Sensitivity analysis • It forces mgt% to identify

Merits of Sensitivity analysis

It forces mgt% to identify the underlying variables and their interrelationships.

It shows how robust a project is to changes in the underlying variables.

It indicates the need for further work.

Limitations:

Avoiding risk characteristics.

Having one factor variation and keeping balance factor to be constant is difficult task.

Scenario Analysis In sensitivity analysis, typically one variable is varied at a time. If variable are inter-related as they are most likely to be, it is helpful to look at some plausible scenarios, each scenario representing a consistent combination of variables.

Projected may be evaluated under three different scenarios

Normal Scenario. {Avg demand, Avg S.P.}

Optimistic Scenario. {High DD, High S.P. but low V.C.}

Pessimistic Scenario. {Low DD, Low S.P. but high V.C.}

For Example:

The base case scenario where the demand and price are expected to be normal.

The scenario where the demand is high but the price low. The scenario where the demand is low but the price high.

MONTE CARLO SIMULATION It will be used for developing the probability profile of a criterion of merit by randomly combining values of variables which have a bearing on the chosen criterion.

Procedure

Model of the project.

Specify the values of parameters and the probability distributions of the exogenous variables.

• Specify the values of parameters and the probability distributions of the exogenous variables. SJBIT/MBA Page
• Specify the values of parameters and the probability distributions of the exogenous variables. SJBIT/MBA Page

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PROJECT APPRAISAL, PLANNING AND CONTROL 12MBAFM425 • Select a value, at random, from the probability distributions

Select a value, at random, from the probability distributions of each of the exogenous variables.

Determine the NPV corresponding to the randomly generated values of exogenous variables and pre specified parameter values.

Repeat steps 3 and 4 a number of times to get a large number of simulated NPV. Plot the frequency distribution of the NPV.

Decision Tree Analysis Steps in Decision Tree Analysis:

Identifying the problem and alternatives.

Delineating the decision tree.

Specifying probabilities and monetary outcomes.

Evaluating various decision alternatives.

Selection of a Project

Risk profile method.

Certainty equivalent method.

Risk adjusted discount rate method.

Risk Analysis in Practice

Conservative estimation of revenues.

Safety margin in cost figures.

Flexible Investment Yardsticks.

Acceptable overall certainty index.

Judgement on three point estimates.

Room for improvement.

Special decision situations:-

Choice between mutually exclusive projects of unequal life.

Optimal timing decision.

Determination of economic life.

exclusive projects of unequal life. • Optimal timing decision. • Determination of economic life. SJBIT/MBA Page
exclusive projects of unequal life. • Optimal timing decision. • Determination of economic life. SJBIT/MBA Page

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PROJECT APPRAISAL, PLANNING AND CONTROL 12MBAFM425 • Interrelationship between investment and financing aspects. •

Interrelationship between investment and financing aspects.

Inflation and capital budgeting. Choice between mutually exclusive projects of unequal life

Based on cost. {specifically to the operating cost.}

Based on life of the asset.

Based on replacement cost and period.

Optimal timing decision

Certain conditions easy to invest.

Uncertainty conditions minimise the possibility of an inverstor and risk will be higher as a result return will also be high.

Determination of economic life

The economic life of an asset refers to the number of years the asset should be used to produce a certain output. It has been influenced by:-

Operating and maintenance cost.

Capital cost.

Interrelationship between investment and financing aspects

Adjusted NPV.

Adjusted Cost of Capital. {Equity and Debt}

Inflation and capital budgeting

Inflation has been a persistent feature of the Indian economy. Hence it should be properly considered in capital investment appraisal.

The adjustment for inflation in project appraisal should be made properly.

Analysis of Firm and Market Risk:-

Portfolio theory and capital budgeting.

Capital asset pricing model.

Estimation of key factors.

CAPM and Capital Budgeting.

• Capital asset pricing model. • Estimation of key factors. • CAPM and Capital Budgeting. SJBIT/MBA
• Capital asset pricing model. • Estimation of key factors. • CAPM and Capital Budgeting. SJBIT/MBA

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PROJECT APPRAISAL, PLANNING AND CONTROL 12MBAFM425 Module V (5 Hours) Social Cost Benefit Analysis(SCBA): Rationale for

Module V (5 Hours)

Social Cost Benefit Analysis(SCBA): Rationale for SCBA UNIDO approach to SCBA Little and Mirle approach to SCBA.

Social Cost Benefit Analysis (SCBA) Rationale for SCBA

• Market Imperfections.

• Externalities.

• Taxes and subsidies.

Concern for savings.

Concern for Redistribution.

UNIDO Approach to SCBA UNIDO approach emerged in 1960s. This approach was initially articulated in the “Guidelines for Project Evaluation” which provides a special framework for SCBA, especially in developed countries. UNIDO method of project appraisal involves five stages

Calculation of the financial profitability of the project measured at market prices.

Obtaining the net benefit of the project measured in terms if economic (efficiency) prices.

Adjustment for the impact of the project on savings and investment.

Adjustment for the impact of the project on income and distribution.

Adjustment for the impact of the project on merit goods and demerit goods whose social values differ from their economic values.

Each of the above stages helps in feasibility of the project from different angles.

Stage 1- The measurement of financial profitability is similar to financial evaluation of the company. Stage 2- It is concerned with determination of net benefits of the project in terms of economic (efficiency) prices. It is also called as shadow prices.

benefits of the project in terms of economic (efficiency) prices. It is also called as shadow
benefits of the project in terms of economic (efficiency) prices. It is also called as shadow

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PROJECT APPRAISAL, PLANNING AND CONTROL 12MBAFM425 Stage 3 & 4- These stages are concerned with measuring

Stage 3 & 4- These stages are concerned with measuring the value of a project in terms of its contribution to savings and income redistribution. In order to make such assessment, the income gained or lost by individual groups in the society is measured. Stage 5 A merit good is one for which social value exceeds economic value. And a demerit good is one for which social value is less than economic value. The difference between social value and economic value has to be adjusted in the right directio n.

Little-Mirrlees approach I.M.D Little and J.A Mirrlees have developed an approach to social cost benefit analysiswhich became popular as Little-mirrlees approach (L-M approach).

There is a considerable similarity between the UNIDO approach and L-M approach. Both approaches call for:

• Calculating accounting (shadow) prices particularly for foreign exchange savings and unskilled labour. • Considering the factor of equity. • Use of DCF analysis.

Despite of the above similarities, there are some differences which are as follows:

• UNIDO approach is limited to domestic boundaries (measures cost and benefits in terms of

domestic rupees) where as L-M approach considers international aspects also (measures cost and benefit in terms of international/border prices).

• UNIDO approach measures cost and benefits in terms of consumption where as the L -M

approach measures cost and benefits in terms of uncommitted social income.

• The UNIDO approach focuses on efficiency, savings and redistribution aspects indifferent

stages. L-M approach tends to view these aspects together.

and redistribution aspects indiffe rent stages. L-M approach tends to view these aspects together. SJBIT/MBA Page
and redistribution aspects indiffe rent stages. L-M approach tends to view these aspects together. SJBIT/MBA Page

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PROJECT APPRAISAL, PLANNING AND CONTROL 12MBAFM425 Module VI (4 Hours) Multiple projects and constraints : Constraints

Module VI (4 Hours) Multiple projects and constraints: Constraints methods of ranking mathematical programming approach linear programming model Qualitative Analysis: Qualitative factors in capital budgeting strategic aspects strategic planning and financial analysis informational asymmetry and capital budgeting organizational considerations. Environmental appraisal of projects: types and dimensions of a project meaning and scope of environment Environment Environmental resources values environmental impact assessment and environmental impact statement.

Constraints

Project Dependence

Capital Rationing

Project indivisibility

Project Dependence

Kind of economic dependency Mutually exclusive Not Mutually exclusive Positive economic dependency

Capital Rationing

Capital Rationing exists when funds available for investment are inadequate to undertake all projects which are otherwise acceptable

Project indivisibility

A capital project has to be accepted or

rejected- it cannot be accepted partially

Approaches available

Method Of Ranking

Method Of Mathematical Programming

accepted partially Approaches available • Method Of Ranking • Method Of Mathematical Programming SJBIT/MBA Page 44
accepted partially Approaches available • Method Of Ranking • Method Of Mathematical Programming SJBIT/MBA Page 44

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PROJECT APPRAISAL, PLANNING AND CONTROL 12MBAFM425 Method Of Ranking 2 Steps in Method Of Ranking 1.

Method Of Ranking

2 Steps in Method Of Ranking

1. Rank all projects

2. Accept project

Problems

1. Conflict in Ranking

2. Project indivisibility

Feasible Combinations Approach

Feasible Combinations Approach

Define all combination of projects

Choose the feasible combination that has the highest NPV Mathematical Programming Approach

Help

in

determining

the

optimal

solution

without

Explicitly

Combinations

2 Broad Categories

1. Objective Function

2. Constraint Equations

Linear Programming Model

Assumptions

evaluating

all

Possible

1. Objective Function &Constraint Equations are Linear

2. All the Coefficients in the objective Function &Constraint Equations are defined with certainty

3. Objective Function is Unidimensional

4. Decision Variables are Considered to be continuous

5. Resources are homogeneous

is Unidimensional 4. Decision Variables are Considered to be continuous 5. Resources are homogeneous SJBIT/MBA Page
is Unidimensional 4. Decision Variables are Considered to be continuous 5. Resources are homogeneous SJBIT/MBA Page

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PROJECT APPRAISAL, PLANNING AND CONTROL 12MBAFM425 Qualitative Factors and Judgment in Capital Budgeting In theory, the

Qualitative Factors and Judgment in Capital Budgeting

In theory, the use of sophisticated techniques is emphasized since they maximize value to shareholders. In practice, however, companies, although tending to shift to the formal methods of evaluation, give considerable importance to qualitative factors. Most companies in Asia guided one time or other, by three qualitative factors:

Urgency

Strategy

Environment

All companies think that urgency is the most important consideration while a large number thinks that strategy plays a significant role. Some companies also consider intuition, security and social considerations as important qualitative factors. Companies in USA consider qualitative factors like employees‟ morals and safety, investor and customer image, or legal matters important in investment analysis.

Due to the significance of qualitative factors, judgment seems to play an important role. Some typical responses of companies about the role of judgment are:

Vision

of

judgment

of

the

future

plays

an

important

role.

Factors

like

market

potential,

possibility

of

technology

change,

trend

of

government

policies,

which

are

judgmental,

play

importance role.

The opportunities and constraints of selecting a project, its evaluation of qualitative and quantitative factors, and the weight age on every bit of pros and cons, cost-benefit analysis, are essential elements of judgment. Thus, it is inevitable for any management decision.

analysis, are essential elements of judgment. Thus, it is inevitable for any management decision. SJBIT/MBA Page
analysis, are essential elements of judgment. Thus, it is inevitable for any management decision. SJBIT/MBA Page

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PROJECT APPRAISAL, PLANNING AND CONTROL 12MBAFM425 Judgment and intuition should definitely be used when a decision

Judgment and intuition should definitely be used when a decision of choice has to be made between two or more, closely beneficial projects, or when it involves changing the long-term strategy of the company.

It plays a very important role in determining the reliability of figures with the help of quantitative methods as well as other known financial matters affecting the projects.

THE PROCESS OF STRATEGIC PLANNING and FIANANCIAL ANALYSIS

Strategic planning is to a business what a map is to a road rally driver. It is a tool that defines the routes that when taken will lead to the most likely probability of getting from where the business is to where the owners or stakeholders want it to go. And like a road rally, strategic plans meet detours and obstacles that call for adapting and adjusting as the plan is implemented.

Strategic planning is a process that brings to life the mission and vision of the enterprise. A strategic plan, well-crafted and of value, is driven from the top down; considers the internal and external environment around the business; is the work of the managers of the business; and is communicated to all the business stakeholders, both inside and outside of the company.

As a company grows and as the business environment becomes more complex the need for strategic planning becomes greater. There is a need for all people in the corporation to understand the direction and mission of the business. Companies consistently applying a disciplined approach to strategic planning are better prepared to evolve as the market changes and as different market segments require different needs for the products or services of the company.

The benefit of the discipline that develops from the process of strategic planning, leads to

company. The benefit of the discipline that develops from the process of strategic planning, leads to
company. The benefit of the discipline that develops from the process of strategic planning, leads to

PROJECT APPRAISAL, PLANNING AND CONTROL

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PROJECT APPRAISAL, PLANNING AND CONTROL 12MBAFM425 improved communication. It facilitates effective decision-making,

improved communication. It facilitates effective decision-making, better selection of tactical options and leads to a higher probability of achieving the owners‟ or stakeholders‟ goals and objectives.

There is no one formula or process for strategic planning. There are however, principles and

required

The steps in the process

described in this series of articles on strategic planning are presented below:

steps

that

optimize

the

value

of

strategic

planning.

Current Situation Analysis

Segmentation Analysis

Strength, Weakness, Opportunities, and Threat Analysis

Core Competencies Analysis

Key Success Factors

Business Unit Strategy / Business Plan

Balanced Score Card

Evaluation

The principles and steps of this process will be discussed in a series of articles following this

introduction to strategic planning. The choice, of the planning process that works best, should be driven by the culture of the organization, and by the comfort level of the participants. The strategic planning process must mirror the cultural values and goals of the company.

There are a number of important steps to remember in the process of strategic planning. They include collecting a meaningful and broad data base, creatively thinking about differentiation, defining gaps, assessing core competencies, and understanding the identifying critical resources and skills.

An important distinction in the process is to recognize the difference between strategic planning, or the work being done, and strategic thinking, or the creative, intuitive input. The planning element involves the data collection, goal setting, expectation definition and statement of direction. Strategic thinking includes the intuitive and creative elements. This thinking process takes into account and helps to leverage the values of the internal culture of the business and external characteristics of the market.

the values of the internal culture of the business and external characteristics of the market. SJBIT/MBA
the values of the internal culture of the business and external characteristics of the market. SJBIT/MBA

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PROJECT APPRAISAL, PLANNING AND CONTROL 12MBAFM425 Strategic planning can be a challenging process, particularly the

Strategic planning can be a challenging process, particularly the first time it is undertaken in a company. With patience and perseverance as well as a strong team effort the strategic plan can be the beginning of improved and predictable results for a company. At times when the business gets off track a strategic plan can help direct the recovery process. When strategic planning is treated as an ongoing process it becomes a competitive advantage and an offensive assurance of improved day to day execution of the business practices.

Environment:

Environment The environment of any organization is "the aggregate of all conditions, events and influences that surround and affect it".

Characteristics of Environment :

Characteristics of Environment Environment is complex :- The environment consists of a number of factors, events, conditions, and influences arising from different sources. All these do not exist in isolation but interact with each other to create entirely new sets of influences Environment is dynamic . The environment is constantly changing in nature. Due to the many and varied influences operating, there is dynamism in the environment, causing it to change its shape and character continuously

Environment is multi- faceted. What shape and character an environment will assume depends on the perception of the observer. A particular change in the environment, or a new development, may be viewed differently by different observers. This is seen frequently when the same development is welcomed as an opportunity by one company while another company perceives it as a threat.

Environment has afar-reaching impact . The environment has a far-reaching impact on organizations. The growth and profitability of an organization depends critically on the environment in which it exists. Any environmental change has an impact on the organization in several different ways

which it exists. Any environmental change has an impact on the organization in several different ways
which it exists. Any environmental change has an impact on the organization in several different ways

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PROJECT APPRAISAL, PLANNING AND CONTROL 12MBAFM425 External & Internal Environment: External & Internal

External & Internal Environment:

External & Internal Environment The external environment includes all the factors outside the organization which provide opportunities or pose threats to the organization. The internal environment refers to all the factors within an organization which impart strengths or cause weaknesses of a strategic nature

An opportunity is a favorable condition in the organization's environment which enables it to consolidate and strengthen its position. An example of an opportunity is a growing demand for the products or services that a company provides. A threat is an unfavorable condition in the organization's environment which creates a risk for, or causes damage to, the organization. An example of a threat is the emergence of strong new competitors who are likely to offer stiff competition to the existing companies in an industry.

A strength is an inherent capacity which an organization can use to gain strategic advantage. An example of a strength is superior research and development skills which can be used for new product development so that the company can gain a strategic advantage. A weakness is an inherent limitation or constraint which creates strategic disadvantages. An example of a weakness is over dependence on a single product line, which is potentially risky for a company in times of crisis

SWOT Analysis:

SWOT Analysis Business firms undertake SWOT analysis to understand their external and internal environmental SWOT which is the acronym for strengths, weakness, opportunities and threats, is also Known as WUTS - UP or TOWS analysis

ENVIRONMENTAL SECTORS:

ENVIRONMENTAL SECTORS Market Environment Customer or client factors , such as, the needs, preferences, perceptions, attitudes, values, bargaining power, buying behavior and satisfaction of customers Product factors , such as, the demand, image, features, utility, function, design, life cycle, price, promotion, distribution, differentiation, and the availability of substitutes of products or services.

promotion, distribution, differentiation, and the availability of substitutes of products or services. SJBIT/MBA Page 50
promotion, distribution, differentiation, and the availability of substitutes of products or services. SJBIT/MBA Page 50

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PROJECT APPRAISAL, PLANNING AND CONTROL 12MBAFM425 Marketing intermediary factors , such as, levels and quality of

Marketing intermediary factors , such as, levels and quality of customer service, middlemen, distribution channels, logistics, costs, delivery systems, and financial intermediaries. Competitor- related factors , such, as the different types of competitors, entry and exit of major competitors, nature of competition, and the relative strategic position of major competitors. Factors Affecting Environmental Appraisal :

Factors Affecting Environmental Appraisal Strategist-related factors . There are many factors related to the strategist, which affect the process of environmental appraisal. Since strategists play a central role in the formulation of strategies, their characteristics such as age, education, experience, motivation level, cognitive styles, ability to withstand time pressures and strain, and so on, have an impact on the extent to which the) are able to appraise their organization's environment, and how well they are able to do it.

Organization-related factors . Like those of the strategists, many characteristics of an organization also have an impact on the environmental appraisal process. These characteristics are the nature of business the organization is in, its age, size and complexity, the nature of its markets, and the pro ducts or services that it provides.

Environment-related factors. The nature of the environment facing an organization determines the way its appraisal could be done. The nature of the environment depends on its complexity, volatility or turbulence, hostility, and diversity.

Structuring Environmental Appraisal :

Structuring Environmental Appraisal Environmental threat and opportunity profile (ETOP) for an organization. The preparation of ETOP involves dividing the environment into different sectors and then analyzing the impact of each sector on the organization. A comprehensive ETOP requires subdividing each environmental sector into sub factors and then the impact of each sub factor on the organization is described in the form of a statement

Environmental appraisal of projects What is project appraisal?

described in the form of a statement Environmental appraisal of projects What is project appraisal? SJBIT/MBA
described in the form of a statement Environmental appraisal of projects What is project appraisal? SJBIT/MBA

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PROJECT APPRAISAL, PLANNING AND CONTROL 12MBAFM425 A process of analyzing the technical feasibility and economic

A process of analyzing the technical feasibility and economic viability of a project proposal with a view to financing their costs.

Importance of project appraisal

It is a capital investment decision

It has long term effects

Decision once taken is irreversible

Expenditures are high

Difficulties in respect of project appraisal

Measurement of costs and potential benefits are difficult

High degree of uncertainty

Long term spread ±time value of money

Types of projects

Mandatory investment (to comply with statutory requirement)

Replacement investment

New projects

Expansion projects

Diversification projects

Research and Development projects

Public good /social welfare projects

Infrastructure projects

Environmental Appraisal of Projects

• Feasibility Approach

Whether the proposed project will meet the minimum environmental standards (legal) of the

country?

• Going beyond minimum standard

Whether it can go beyond minimum standards and achieve environmental certification such as ISO 14,000 (general) and LEED certification (building/ construction)?

certification such as ISO 14,000 (general) and LEED certification (building/ construction)? SJBIT/MBA Page 52
certification such as ISO 14,000 (general) and LEED certification (building/ construction)? SJBIT/MBA Page 52

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PROJECT APPRAISAL, PLANNING AND CONTROL 12MBAFM425 – Whether the project/company can demonstrate leadership in the

Whether the project/company can demonstrate leadership in the field of environmental protection/augmentation by making it part of its core business?(ecological entrepreneurship).

Approach to Environmental Feasibility

• Reactive approach (majority)

EIA carried out with sole purpose of getting environmental clearance.

• Proactive approach (small minority)

EIA as a tool to improve planning process

EIA as an opportunity to internalize externalities and gain long term benefits:

• Improved cost-effectiveness

• Earn carbon credits

• Recovery of resources from waste streams

• Better and safer work environment

• Less occupational hazards • Better image as responsible citizen of the country

Environmental Feasibility:

Legal Requirements and Procedures EIA Notifications EIA Process Legal Requirements

• 27th Jan 1994 Notification of MoEF, GoI under the Environmental (Protection) Act 1986 making environmental clearance mandatory for expansion/ modernisation of any activity or setting up new projects listed under Schedule 1(29 industries)

• 12 minor Amendments between 1994 to 2006

• 14th Sept. 2006 Notification in supersession of earlier notification of 1994.

2007 Notifications to constitute various state level Environment Impact Assessment authorities.

EIA Notification (1994)

• 29 industries will need environmental clearance from MoF,GoI.

EIA Notification (1994) • 29 industries will need en vironmental clearance from MoF,GoI. SJBIT/MBA Page 53
EIA Notification (1994) • 29 industries will need en vironmental clearance from MoF,GoI. SJBIT/MBA Page 53

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PROJECT APPRAISAL, PLANNING AND CONTROL 12MBAFM425 • For expansion or new ventures with investment > Rs.

• For expansion or new ventures with investment > Rs. 50 crores

• MoEF to act as Impact Assessment Agency (IAA)

can appoint an expert committee if needed

May organise public hearing if needed

• Assessment within 90 daysof receiving documents or public hearing

• Validity of clearance for 5 years

• Site clearance in case of a few industries like mining etc. needed before project preparation Amendments to 1994 Notification

• Between 1994 to 2006 – 12 Amendments

• 10th April 1999 – Process of environmental public hearing by SPCB introduced; Public hearing committee to ensure fair representation in hearinigs

• 4th Aug. 2003

kms.

MoEF. 7th July 2004 – environmental clearance made mandatory for construction and industrial

estates.

Of ecologically sensitive areas like sanctuaries, bio-reserves etc. need clearance from

Location sensitivity: projects located in critically polluted areas; within 15

EIA Notification (2006)

Partial Decentralization

Category A clearance by MoEF

Category B clearance by State regulatory authority (SPCB)

• B 1- will require EIA

• B2 – will not require

Above categories based on size, capacity, area rather than investment level

Formation of Environmental Impact Assessment Agency and Environmental Expert Committee at Central and State levels

Introduction of Scoping process

TOR to be determined by Expert Appraisal Committees

• Based on information provided by proponent

• May visit site if needed

• Within 60 days of application

on information provided by proponent • May visit site if needed • Within 60 days of
on information provided by proponent • May visit site if needed • Within 60 days of

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PROJECT APPRAISAL, PLANNING AND CONTROL 12MBAFM425 • To be displayed on MoEF/ SPCB‟s website Public consultation

• To be displayed on MoEF/ SPCB‟s website

Public consultation

Necessary for Category A, B1 except for 6 activities

SPCB to conduct public hearings for which procedure outlined

To ascertain view of local people

To gather written responses of interested parties like experts, NGOs etc.

MoEF to display summary of EIA on website; full draft in public reference place

Video-graphy of proceedings by SPCB

Appraisal

Of EIA to be done by Expert Committee at state or Central levels

Within 60 days, with recommendation to regulatory authority

Decision making

Regulatory authority to give decision within 45 days i.e 105 days of receipt of final EIA/

application

Failing which, - default clearance

Post-clearance monitoring

Bi-annual compliance reports to regulating authority Latest report to be displayed on website of regulating authority

EIA Concepts/ stages

Screening: determines whether the proposed project requires an EIA and if so, at what level of

assessment?

Scoping: identifies the key issues and impacts that should be further investigated; defines the

boundaries and time limit of study

Impact analysis: identifies and predicts likely environmental and social impacts and evaluates their significance

Mitigation: recommends the actions to reduce and avoid the potential adverse environmental consequences of the project

the actions to reduce and avoid the potential adverse environmental consequences of the project SJBIT/MBA Page
the actions to reduce and avoid the potential adverse environmental consequences of the project SJBIT/MBA Page

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PROJECT APPRAISAL, PLANNING AND CONTROL 12MBAFM425 • Reporting : presents the result of EIA in the

Reporting: presents the result of EIA in the form of a report to the decision making body and other interested parties

Review: examines the adequacy and effectiveness of the EIA report and provides information

necessary for decision-making.

adequacy and effectiveness of the EIA report and provides information necessary for decision-making . SJBIT/MBA Page
adequacy and effectiveness of the EIA report and provides information necessary for decision-making . SJBIT/MBA Page

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PROJECT APPRAISAL, PLANNING AND CONTROL 12MBAFM425 Module VII (5 Hours) Project financing in India: Means of

Module VII (5 Hours) Project financing in India: Means of finance norms and policies of financial institutions SEBI guidelines Sample financing plans structure of financial institutions in India schemes of assistance term loans procedures project appraisal by financial institutions.

Means of Finance

1. Share capital.

2. Term loans.

3. Debenture capital.

4. Deferred credit.

Norms and policies of financial institutions by RBI:

On a review of the credit exposures of the term lending institutions in 1997, it was considered advisable to prescribe credit exposure limits for them in respect of their lending to individual / group borrowers. Accordingly, as a prudential measure, aimed at better risk management and avoidance of concentration of credit risks, it was decided in June 1997 by Reserve Bank of India to limit a term lending institution's exposures to an individual borrower and group borrowers and credit exposure norms were prescribed for them. These norms are to be considered as a part of prudent credit management system and not as a substitute for efficient credit appraisal, monitoring and other safeguards. In respect of existing credit facilities to borrowers which were in excess of the ceilings initially prescribed, term lending institutions were required to take necessary steps to rectify the excess and comply with the stipulations, within a period of one year from June 28, 1997, the date of the first circular, and to bring such cases to the notice of their Board of Directors.

2.Scope and Applicability

2.1 The exposure norms are also applicable to the refinancing institutions (viz., NABARD, NHB and SIDBI) but in view of the refinance operations being the core function of these institutions,

NHB and SIDBI) but in view of the refinance operations being the core function of these
NHB and SIDBI) but in view of the refinance operations being the core function of these

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PROJECT APPRAISAL, PLANNING AND CONTROL 12MBAFM425 their refinance portfolio is not subject to these exposure norms.

their refinance portfolio is not subject to these exposure norms. However, from the prudential perspective, the refinancing institutions are well advised to evolve their own credit exposure limits, with the approval of their Board of Directors , even in respect of their refinancing portfolio. Such limits could, inter alia, be related to the capital funds / regulatory capital of the institution. Any relaxation / deviation from such limits, if permitted, should be only with the prior approval of the Board.

2.2 While computing the extent of exposures to a borrower / borrower group for assessing

compliance vis-a-vis the single borrower limit / group borrower limit, exposures where principal and interest are fully guaranteed by the Government of India may be excluded.

2.3 These norms deal with only the individual borrower and group borrower exposures but not

with the sector / industry exposures. The FIs may, therefore, consider fixing internal limits for aggregate commitments to specific sectors e.g., textiles, chemicals, engineering, etc., so that the exposures are evenly spread. These limits should be fixed having regard to the performance of different sectors and the perceived risks. The limits so fixed should be reviewed periodically and revised, if necessary.

For Group Borrowers

The credit exposure to the borrowers belonging to a group shall not exceed 40 per cent of capital funds of the FI. However, the exposure may exceed by additional ten percentage points (i.e., up to 50 per cent) provided the additional credit exposure is on account of infrastructure projects. FIs may, in exceptional circumstances, with the approval of their Boards, consider enhancement of the exposure to a borrower up to a further 5 per cent of capital funds (i.e. 55 percent o f capital funds for infrastructure projects and 45 percent for other projects).

[The exposure ceilings stipulated initially in 1997 were 25 per cent and 50 per cent of the capital funds of the FIs for the individual and group borrowers, respectively. In September 1997, an additional exposure of up to 10 percentage points for the group borrowers (i.e., up to 60 per cent) was permitted provided the additional credit exposure was on account of infrastructure projects (which at that time were narrowly defined as only power, telecommunication, roads and ports). In November 1999, with a view to moving closer to the international standard of 15 per cent

ports). In November 1999, with a view to moving closer to the international standard of 15
ports). In November 1999, with a view to moving closer to the international standard of 15

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PROJECT APPRAISAL, PLANNING AND CONTROL 12MBAFM425 exposure ceiling, the individual borrower exposure ceiling was

exposure ceiling, the individual borrower exposure ceiling was reduced, with effect from April 1, 2000, from 25 per cent to 20 percent of capital funds. The FIs which had, as on October 31, 1999, exposures in excess of the reduced limit of 20 per cent, were permitted to reduce their exposures to the level of 20 per cent latest by October 31, 2001. In June 2001, the exposure ceilings for the individual and group borrowers were reduced from 20 percent and 50 per cent to 15 percent and 40 per cent, respectively, with effect from April1, 2002 , but the additional exposure in respect of group borrowers, of up to 10 percentage points on account of infrastructure projects was continued. In February 2003 , an additional exposure of up to five percentage points (i.e., up to 20 percent) on account of infrastructure projects was permitted in respect of individual borrowers also].

4.3 For Bridge Loans / Interim Finance

4.3.1 With effect from January 23, 1998, the restriction on grant of bridge loans by the FIs

against expected equity flows / issues has been lifted. Accordingly, FIs may henceforth grant bridge loan / interim finance to companies other than NBFCs against public issue of equity

whether in India or abroad, for which appropriate guidelines should be laid down by the Board of the Financial Institution, as prescribed by RBI. However, FIs should not grant any advance

against Rights issue irrespective

of the source of repayment of such advance.

4.3.2 FIs may sanction bridge loans to companies for commencing work on projects pending

completion of formalities only against their own commitment and not against loan commitment of any other FIs / Banks. However, FIs may consider sanction of bridge loan / interim finance against commitment made by a financial institution and / or another bank only in cases where the lending institution faces temporary liquidity constraint, subject to certain conditions prescribed by RBI.

4.3.3 These restrictions are also applicab le to the subsidiaries of FIs for which FIs are required to

issue suitable instructions to their subsidiaries.

subsidiaries of FIs for which FIs are required to issue suitable instructions to their subsidiaries. SJBIT/MBA
subsidiaries of FIs for which FIs are required to issue suitable instructions to their subsidiaries. SJBIT/MBA

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PROJECT APPRAISAL, PLANNING AND CONTROL 12MBAFM425 4.4 Working Capital Finance There is no objection to FIs

4.4 Working Capital Finance

There is no objection to FIs extending working capital finance on a very selective basis to borrowers enjoying credit limits with banks, whether under a consortium or under a multiple banking arrangement, when the banks are not in a position to meet the cr edit requirements of the borrowers concerned on account of temporary liquidity constraints. The FIs should take into account these guidelines while granting short term loans to borrowers enjoying credit limits with banks on a consortium basis. In case of b orrowers whose working capital is financed under a multiple banking arrangement, the FI should obtain an auditor's certificate indicating the extent of funds already borrowed, before considering the borrower for further working capital finance.

Investment in Debt Securities

The total investment in the unlisted debt securities should not exceed 10 per cent of the FIs' total investment in debt securities as given in guidelines for investment in debt securities, as on March 31 (June 30 in case of NHB), of the previous year. However, the investment in the following instruments will not be reckoned as 'unlisted debt securities' for monitoring compliance with the above prudential limits :

i.

Security Receipts (SRs) issued by Securitisation Companies / Reconstruction Companies registered with RBI in terms of the provisions of the Securitisation and Reconstruction of Financial Assets and Enforcement of Securities Interest (SARFAESI) Act, 2002; and

ii.

Asset Backed Securities (ABS) and Mortgage Backed Securities (MBS) which are rated at or above the minimum investment grade.

4.8

Investment in Venture Capital Funds (VCF)

FIs are advised to comply with the prudential requirements relating to financing of venture capital funds (VCF) set out at

4.9 Cross Holding of Capital among Banks / Financial Institutions

capital funds (VCF) set out at 4.9 Cross Holding of Capital among Banks / Financial Institutions
capital funds (VCF) set out at 4.9 Cross Holding of Capital among Banks / Financial Institutions

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PROJECT APPRAISAL, PLANNING AND CONTROL 12MBAFM425 (i) FIs' investment in the following instruments, which are

(i) FIs' investment in the following instruments, which are issued by other banks / FIs and are

eligible for capital status for the investee bank / FI, should not exceed 10 percent of the investing FI's capital funds (Tier I plus Tier II) :

a. Equity shares;

b. Preference shares eligible for capital status;

c. Subordinated debt instruments;

d. Hybrid debt capital instruments; and

e. Any other instrument approved as in the nature of capital.

FIs should not acquire any fresh stake in a bank's / FI's equity shares, if by such acquisition, the investing FI's holding exceeds 5 percent of the investee bank's / FI's equity capital.

(ii) FIs' investments in the equity capital of subsidiaries are at present deducted from their Tier I

capital for capital adequacy purposes. Investments in the instruments issued by banks / FIs which are listed at paragraph 4.8(i) above, which are not deducted from Tier I capital of the investing

FI, will attract 100 percent risk weight for credit risk for capital adequacy purposes.

SECURITIES AND EXCHANGE BOARD OF INDIA & STRUCTURE OF FINANCIAL INSTITUTIONS IN INDIA Objective This memorandum proposes to amend SEBI (Mutual Funds) Regulations, 1996 (MF Regulations) to provide regulatory framework for setting up of Infrastructure Debt Funds (IDFs) by inserting Chapter VI-B to the MF Regulations.

Rationale for Amendments Finance Minister, in his Budget Speech for 2011-2012, announced setting up of Infrastructure Debt Funds (IDFs) in order to accelerate and enhance the flow of long term debt in infrastructure projects for funding Government‟s programme of nfrastructure development.

debt in infrastructure proj ects for funding Government‟s programme of nfrastructure development. SJBIT/MBA Page 61
debt in infrastructure proj ects for funding Government‟s programme of nfrastructure development. SJBIT/MBA Page 61

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PROJECT APPRAISAL, PLANNING AND CONTROL 12MBAFM425 2.2. In 2007 SEBI had set up a Committee to

2.2. In 2007 SEBI had set up a Committee to suggest the broad guidelines for launch and operations of Dedicated Infrastructure Funds. In its report dated July 23, 2007, the report detailed the rationale and modalities of setting up of Dedicated Infrastructure Funds under the MF Regulations. The Committee recommended that the Infrastructure Funds will need to be structured differently from the current Mutual Fund Schemes, as these will largely invest in unlisted companies, with longer gestation periods.

2.3. Pursuant to the Budget Announcements, consultations were held with representatives of

Ministry of Finance, RBI, and industry participants on draft regulatory framework for IDFs under the extant MF Regulations. Taking into consideration views from the Government,

RBI, Infrastructure Companies and potential investors as also the recommendations of the aforesaid Committee Report, it was agreed that Infrastructure Debt Funds may be set up under the existing Mutual Fund Regulations by providing for a separate Chapter for the same.

2.4. A letter dated (the date has been excised for reasons of confidentiality) has also been

received from Secretary, Ministry of Finance enclosing broad structure of IDFs as approved

by the Finance Minister. (Annexure B)

2.5. Accordingly, Draft Chapter VI-B to the MF Regulations has been prepared for providing

a regulatory framework for IDFs. (Annexure A) 3. Salient features of Regulatory Framework for IDF Scheme

3.1. The IDFs could be set up by any existing mutual fund. Applications from companies

which have been carrying on activities or business in infrastructure financing sector for a period of not less than five years and fulfill the eligibility criteria provided in Regulation 7 of Mutual Fund Regulations will also be considered for setting up Mutual Funds exclusively for the purpose of launching IDF Scheme.

3.2. The IDF would invest 90 per cent of its assets in the debt securities of infrastructure

companies or SPVs across all infrastructure sectors. Minimum investment by IDF would be Rs 1 crore with Rs 10 lakh as minimum size of the unit. The credit risks associated with underlying securities will be borne by the investors. 3.3. An infrastructure debt fund scheme shall be launched either as close-ended scheme

maturing after more than five years or Interval scheme with lock-in of five years.

close-ended scheme maturing after more than five years or Interval scheme with lock-in of five years.
close-ended scheme maturing after more than five years or Interval scheme with lock-in of five years.

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PROJECT APPRAISAL, PLANNING AND CONTROL 12MBAFM425 3.4. Units of infrastructure debt fund schemes shall be listed

3.4. Units of infrastructure debt fund schemes shall be listed on a recognized stock exchange.

3.5. An Infrastructure debt fund shall have minimum 5 investors and no single investor shall

hold more than 50% of net assets of the scheme

4. Proposal

4.1. The Board Memorandum proposes to amend SEBI (Mutual Funds) Regulations, 1996 by

inserting Chapter VI-B, on Infrastructure Debt Fund Schemes. The proposed draft Mutual Fund Amendment Regulation 2011 is enclosed as Annexure A for consideration and approval.

4.2. The Board is requested to consider and approve the above and authorize the Chairman to

make and notify such consequential and incidental changes and amendments to the SEBI (Mutual Funds) Regulations, 1996 as may be necessary and appropriate to implement the decision of the Board.

(MUTUAL FUNDS) (AMENDMENT) REGULATIONS, 2011 In exercise of the powers conferred by section 30 of the Securities and Exchange Board

of India Act, 1992 (15 of 1992), the Board hereby makes the following regulations to further amend the Securities and Exchange Board of India (Mutual Funds) Regulations, 1996, namely :-

1. These regulations may be called the Securities and Exchange Board of India (Mutual

Funds) (Amendment) Regulations, 2011.

2. They shall come into force on the date of their publication in the Official Gazette.

3. In the Securities and Exchange Board of India (Mutual Funds) Regulations, 1996, the

following chapter VI B shall be inserted after VIA.

INFRASTRUCTURE DEBT FUND SCHEMES

(1) “Infrastructure debt fund scheme” means a mutual fund scheme that invests primarily (minimum 90% of scheme assets) in the debt securities or securitized debt instrument of infrastructure companies or infrastructure capital companies or infrastructure projects or

of infrastructure companies or infrastructure capital companies or infrastructure projects or SJBIT/MBA Page 63
of infrastructure companies or infrastructure capital companies or infrastructure projects or SJBIT/MBA Page 63

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PROJECT APPRAISAL, PLANNING AND CONTROL 12MBAFM425 special purpose vehicles which are created for the purpose of

special purpose vehicles which are created for the purpose of facilitating or promoting investment in infrastructure, and other permissible assets in accordance with these regulations or bank loans in respect of completed and revenue generating projects of infrastructure companies or projects or special purpose vehicles.

(2) Infrastructure includes the sectors as specified by SEBI Guidelines or as notified by

Ministry of Finance from time to time

(3) „Strategic Investor‟ means; (i) an Infrastructure Finance Company registered with RBI as NBFC.

(ii)

a Scheduled Commercial Bank;

(iii)

International Multilateral Financial Institution.

(1) The provisions of this Chapter shall apply to infrastructure debt fund schemes launched by mutual funds.

(2) Unless the context otherwise requires, all other provisions of Mutual Fund Regulations

and the guidelines and circulars issued thereunder shall apply to infrastructure debt fund

schemes, and trustees and asset management companies in relation to such schemes, unless repugnant to the provisions of this Chapter.

49N. Eligibility criteria for launching IDFS

(1) An existing mutual fund may launch an infrastructure debt fund schemes if it has an

adequate number of key personnel having adequate experience in infrastructure sector.

(2) A certificate of registration may be granted under regulation 9 to an applicant proposing

to launch only Infrastructure Debt Fund Schemes if the sponsor or the parent company of the

sponsor;

(a) has been carrying on activities or business in infrastructure financing sector for a period

of not less than five years;

(b) fulfills eligibility criteria provided in Regulation 7.

Explanation- For the purpose of this clause, „parent company of the sponsor‟ shall mean a

company which holds at least 75% of paid up equity share capital of the sponsor.

shall mean a company which holds at least 75% of paid up equity share capital of
shall mean a company which holds at least 75% of paid up equity share capital of

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PROJECT APPRAISAL, PLANNING AND CONTROL 12MBAFM425 Conditions for infrastructure debt fund schemes (1) An infrastructure

Conditions for infrastructure debt fund schemes

(1) An infrastructure debt fund scheme shall be launched either as close-ended scheme

maturing after more than five years or Interval scheme with lock-in of five years and interval

period not longer than 1 month as may be specified in the scheme information document.

(2) Units of infrastructure debt fund schemes shall be listed on a recognized stock exchange,

provided that such units shall be listed only after being fully paid up.

(3) Mutual Funds may disclose indicative portfolio of infrastructure debt fund scheme to its

potential investors disclosing the type of assets the mutual fund will be investing.

(4) An Infrastructure debt fund shall have minimum 5 investors and no single investor shall

hold more than 50% of net assets of the scheme.

(5) No infrastructure debt fund schemes shall accept any investment, from any investor

which is less than Rupees one crore. (6) The minimum size of the unit shall be Rupees 10 lakhs.

(7) Each scheme launched as infrastructure debt fund scheme shall have firm commitment

from the strategic investors for contribution of an amount of at least Rupees twenty five crores before the allotment of units of the scheme are marketed to other potential investors.

(8) Mutual Funds launching Infrastructure debt fund scheme may issue partly paid units to

the investors. In case partly paid units are issued:

(a) AMCs shall call for the unpaid portions depending upon the deployment opportunities

(b) The offer document of the scheme shall disclose the interest or penalty which may be

deducted in case of non payment of call money by the investors within stipulated time. The amount of interest or penalty shall be retained in the scheme.

Permissible investments

(1) Every Infrastructure debt fund scheme shall invest at least ninety percent of the net assets

of the scheme in the debt securities or securitized debt instruments of infrastructure companies or projects or special purpose vehicles which are created for the purpose of facilitating or promoting investment in infrastructure or bank loans in respect of completed and revenue generating projects of infrastructure companies or special purpose vehicle.

of completed and revenue generating projects of infrastructure companies or special purpose vehicle. SJBIT/MBA Page 65
of completed and revenue generating projects of infrastructure companies or special purpose vehicle. SJBIT/MBA Page 65

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PROJECT APPRAISAL, PLANNING AND CONTROL 12MBAFM425 (2) Subject to sub-regulation (1), every Infrastructure Debt Fund

(2) Subject to sub-regulation (1), every Infrastructure Debt Fund scheme may invest the

balance amount in Equity shares, convertibles including mezzanine financing instruments of companies engaged in infrastructure, infrastructure development projects, whether listed on a

recognized stock exchange in India or not; or money market instruments and bank deposits.

(3) The investment restrictions shall be applicable on the life-cycle of the Infrastructure Debt

Fund Scheme and shall be reckoned with reference to the total amount raised by the

Infrastructure Debt Fund Scheme.

(4) No mutual fund shall, under all its Infrastructure Debt Fund schemes, invest more than

thirty per cent of its net assets in the debt securities or assets of any single infrastructure company or project or special purpose vehicles which are created for the purpose of

facilitating or promoting investment in infrastructure or bank loans in respect of completed and revenue generating projects of any single infrastructure company or project or special purpose vehicle.

(5) An Infrastructure debt scheme shall not invest more than 30% of the net assets of the

scheme in debt instruments or assets of any single infrastructure company or project or special purpose vehicles which are created for the purpose of facilitating or promoting investment in infrastructure or bank loans in respect of completed and revenue generating projects of any single infrastructure company or project or special purpose vehicle, which are rated below investment grade or unrated. Such Investment limit may be extended upto 50% of the net assets of the scheme with the prior approval of the Board of Trustees and AMC Board.

(6) No Infrastructure Debt Fund schemes shall invest in (i) Any unlisted security of the sponsor or its associate or group company; (ii) Any listed security issued by way of preferential allotment by the sponsor or its associate or group company;

(iii) Any listed security of the sponsor or its associate or group company or bank loan in

respect of completed and revenue generating projects of infrastructure companies or SPVs, in excess of twenty five per cent of the net assets of the scheme, subject to approval of trustees and full disclosures to investors for investments made within the aforesaid limits.

of trustees and full disclosures to investors for investments made within the aforesaid limits. SJBIT/MBA Page
of trustees and full disclosures to investors for investments made within the aforesaid limits. SJBIT/MBA Page

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