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COURSE

MANUAL

Programme: BBAI. P. University (Session 201215)


Semester

: VI

Subject

: Project Planning & Evaluation

Code

: BBA - 304

Compiled By : (Prof. Pradip K. Mukherjee)


Dept. of Management
December, 2014

Approved By :
H.O.D. (Management)
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BBA VI Semester : 304 Project Planning & Evaluation


PRIME OBJECTIVES
1. To familiarize students about the basic concepts and models of project planning.
2. To enable students to understand the needs and advantages of expansion and
diversification business opportunities.
3. To acquaint students with the methodology and approach of assessing the
technical, commercial and financial viability of projects.
4. To make students capable of making comparative assessment of profitability
among different business opportunities.
5. To make students conversant about the techniques of implementing and
evaluating performance and progress of various projects.

BBA VI Semester : 304 Project Planning & Evaluation


LESSON
Unit
I

II

III

IV

PLAN

Topic
Project Planning Overview :
Capital investments : Importance & difficulties, Types of capital
investments, Phases of capital budgeting, Levels of decision
making, Facets of project analysis, Feasibility study, Objectives of
capital budgeting, Techniques of capital budgeting.
Capital Allocation Framework & Financing of Projects :
Capital structure, Mean of financing, Equity capital, Preference
capital, Internal accruals, Term loans, Debentures, Working capital
requirement & its financing, Miscellaneous sources, Raising
venture capital, Raising capital in international market.
Cost of project, Estimates of sales & production, Cost of
production, Profitability projections, Projected cash flow
statement, Projected balance sheet.
Market & Demand Analysis :
Conduct of market survey, Characterization of market, Demand
forecasting, Uncertainties in demand forecasting, Market planning.
Technical Analysis :
Manufacturing process / technology, Technical arrangements,
Product mix, Plant capacity, Location & site.
Project Management :
Forms of project organization, Project planning, Project control,
Human aspects of project management.
Network Techniques :
Development of project network, Time estimation (simple
practical problems with EST, EFT, LST, LFT, Total Float),
Determination of critical path, Scheduling when resources are
limited, PERT model, CPM model (simple practical problem of
crashing), Network cost system.
Project Review & Administrative Aspects :
Control of in-progress projects, Post completion audits.
Risk & Analysis Uncertainty :
Using sensitivity, Simulation, Decision & Other techniques.

No. of
Hours
8

4
4
4
6

2
4

BBA VI Semester, I.P. University


304 PROJECT PLANNING & EVALUATION
--------------------------------------------------------------------------------------Unit I :
Project Planning Overview: Capital InvestmentsImportance & Difficulties,
Types of Capital Investments, Phases of Capital Budgeting, Levels of Decision
Making, Facets of Project Analysis, Feasibility Study, Objectives of Capital
Budgeting, Techniques of Capital Budgeting.
Capital Allocation Framework : Financing of Projects : Capital Structure,
Menu of Financing, Equity Capital, Preference Capital, Internal Accruals, Term
Loans, Debentures, Working Capital Requirement & its Financing, Miscellaneous
Sources, Raising Venture Capital, Raising Capital in International Markets.
Cost of Project, Estimates of Sales & Production, Cost of Production, Profitability
Projections, Projected Cash Flow Statement, Projected Balance Sheet.
__________________________________________________________________
1.0 Capital Investment: Capital expenditure is a commitment of current
resources in order to secure a stream of benefits in future years. The value of
benefits received is measured not only in terms of benefits received but also the
timing of their receipt. The net benefits of capital expenditure depend upon the
quality of investment decisions. The quality is judged by weighing the benefits
against risks & uncertainties.
1.1 Importance Capital investment decision is one of the most important
decision taken by any organization must be taken with due care because they
involve high stakes. The importance is arising from 3 inter-related reasons:
Long-term Effects: The consequences of capital investment decisions have a far
reaching effect. The present activities & functions are largely governed by
capital expenditures in the past. Similarly present capital investment decisions
provide framework for future activities.
Irreversibility: A wrong capital investment decision often cannot be reversed
without incurring a substantial loss. The market for used capital goods /
equipment especially tailor-made to meet specific requirements may be
virtually non-existent. Once such an equipment is acquired, reversal of decision
may lead to scrapping the capital equipment leading to substantial loss.
Substantial Outlays: Capital costs tend to increase with advanced technology.
Capital expenditures usually involve substantial outlays.
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1.2 Difficulties The difficulties posed can be broadly described as follows:


Uncertainty: A capital investment decision involves costs & benefits that
extend into the future which is difficult to predict exactly. This is associated
with measurement problems.
Risk element: Benefits from capital expenditure are subject to risk like
judgmental error, wrong estimation, incomplete data, unpredictability of events,
etc.
2.0 Types of Capital Investment: This are often classified by different companies
in different ways for planning & control.
2.1 Physical, Monetary & Intangible Assets
Physical Assets are tangible investments like land, building, plant,
machinery, vehicles, computers, etc.
Monetary Assets are deposits, bonds, shares, etc.
Intangible Assets are different from physical assets & financial claims. They
represent outlays on research, training & development, market development,
etc. that are expected to generate benefits over a period of time.

2.2 Other categories of investments


Strategic investment has a significant impact on the direction of the firm.
Tactical investments implement a current strategy as efficiently or profitably
as possible.
Mandatory investment is a capital expenditure required to comply with
statutory requirements viz. fire-fighting equipment, pollution control measures,
canteen facility, medical aid, etc.
Replacement investment is meant to replace worn out or obsolete equipment
with new modern equipment to reduce operating costs, increase productivity,
improve quality, etc.
Expansion investment is to increase the capacity to cater growing demand.
Diversification investment is aimed at producing new products towards
growth of the organization.
R & D investment is focused to develop new products & improved processes
to sharpen the technological edge of the company.
3.0 Phases of Capital Budgeting:
Capital budgeting may be divided into 6 broad phases
(1) Planning ; (2) Analysis ; (3) Selection ; (4) Financing ; (5) Implementation ;
(6) Review.
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3.1 Planning is concerned with broad investment strategy & preliminary


screening of project proposals. The investment strategy shows the broad
areas or types of investment the firm plans to undertake.
Once a project proposal is identified a preliminary project analysis is done.
This exercise is meant to assess
1.1 Whether the project is prima-facie viable to justify a feasibility study ?
1.2 What aspects of the project are critical to its viability requiring in-depth
investigation.
3.2 Analysis If from the preliminary screening project is prima-facie acceptable,
a detailed analysis of the marketing, technical, financial, economic &
ecological aspects is undertaken.
3.3 Selection A wide range of appraisal criteria is available to judge the
suitability of the project. They are divided into 2 broad categories :
(a) Non-discounting criteria viz. pay back period, accounting rate of return, etc.
(b) Discounting criteria viz. net present value, internal rate of return, benefit
cost ratio, etc.
Criterion
Payback period PBP
Accounting rate of return ARR
Net present value NPV
Internal rate of return IRR
Benefit cost ratio - BCR

Accept
PBP < Target period
ARR > Target rate
NPV > 0
IRR > Cost of capital
BCR > 1

Reject
PBP > Target period
ARR < Target rate
NPV < 0
IRR < Cost of capital
BCR < 1

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


to be made. Two broad sources of finance for a project are equity & debt.
Equity (referred to shareholders funds on balance sheets) consists of paid-up
capital, share premium & retained earnings. Debt (referred to as loan funds on
balance sheets) consists of term loans, debentures & working capital advances.
Flexibility, risk, income, control & taxes (FRICT) influence the capital
structure (debt-equity ratio) decision & the choice of specific instruments of
financing.
3.5 Implementation For an industrial project involving setting up of
manufacturing facilities consists of several stages:
(a) Design & engineering Site probing, acquisition of technology, plant
design & engineering, selection of specific machineries & equipment,
prepare specifications for procurement.
(b) Purchasing & contracting Selection of vendors, issue of enquiries /
tenders, evaluation, placement of orders, receipt / issue of materials, etc.
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Construction & erection Site preparation, civil works, erection &


installation of machinery & equipment, etc.
(d) Commissioning Start up the plant & stabilize operation.
(e) Training Training of all level of employees to be able to take up
responsibility that starts from the beginning.
Translating an investment proposal into a concrete project is a complex, timeconsuming and associated with risk. Delays in implementation, which are
common, can lead to substantial cost over-runs. For implementation of a
project without time & cost over-run maintaining specific quality requirements
the following are helpful:
Adequate formulation of Projects
Responsibility accounting
Network techniques for monitoring
3.6 Review Performance review must be done periodically to compare actual
performance with planned one. In case of deviation or shortfall corrective
actions are required to be taken.
4.0 Levels of Decision Making: There are 3 levels of decision making
Operating, Administrative & Strategic.
Operating decisions are short term with minor resource commitment, routine
matters taken by lower level management.
Administrative decisions are medium term with moderate resource
commitment & semi-structured taken by middle level management.
Strategic decisions have a long term impact with major resource commitment
& unstructured taken by top level management. This influences a larger part of
the system & is difficult to undo once implemented.
5.0 Facets of Project Analysis:
5.1 Market Analysis is concerned with the aggregate demand of the proposed
product/service in future and future market share of the product under appraisal.
The market analysts collect a wide variety of information as mentioned below
& decide appropriate forecasting methods:
Past consumption trends & present consumption level.
Past & present supply position.
Production possibilities & constraints.
Imports & exports.
Structure of competition.
Cost parameters.
Elasticity of demand.
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Consumer behavior, intentions, motivations, attitudes, preferences &


requirements.
Distribution channels & marketing policies in use.
Administrative, technical & legal constraints.
5.2 Technical Analysis covers technical & engineering aspects of a project
viz. choices of location, size, process, etc.

Selection of suitable production process.


Scale of operation.
Availability of raw-materials, power & other infrastructure.
Selection of appropriate equipment & machineries.
Provision for effluent treatment & other legal/social requirements.
Realistic schedule.

5.3Financial Analysis ascertains financial viability to generate return


expectations of the capital after meeting liabilities. It analyses:

Investment outlay & cost of the project.


Means of financing.
Cost of capital.
Projected profitability.
Break-even point.
Cash flow.
Level of risk.

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


concerned with judging a project from the larger social point of view. It
focuses
o What are the direct economic benefits & costs of the project measured in
terms of shadow (efficiency) prices & not in terms of market prices ?
o What would be the impact of the project on the distribution of income and
level of savings / investment in the society ?
o What would be the contribution of the project towards fulfillment of the
certain merits like self-sufficiency, employment, social order, etc. ?
5.5 Ecological Analysis should be done particularly for major projects having
significant ecological implications with respect to pollution, soil erosion, etc.
viz. power plants, chemicals, fertilizers, refineries, steel plants, irrigation
schemes, etc. The key questions are
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What are the likely damage to the environment ?


What are the cost of restoration measures required to ensure that the damage
to the environment is contained within acceptable limits ?
Summary of Key Issues in different types of Project Analysis
------ Potential Market
Market Analysis ------------- Market Share
------ Viability
Technical Analysis ---------- Choices
------ Risk
Financial Analysis ----------- Return
------ Benefits & Costs in shadow prices
Economic Analysis---------- Other Impacts
------ Environmental Damage
Ecological Analysis---------- Restoration Measures
6.0 Feasibility Study: is concerned with planning, analysis & evaluation, selection
and financing involving market, technical, financial, economic & ecological
analysis. Here the viability of the investment is evaluated.
7.0 Objective of Capital Budgeting:
Capital budgeting is a part of strategic planning. The objectives is to maximize the
market value of the firm to its shareholders or shareholders wealth maximization.
Identification of investment opportunities with merit. It involve cost of capital
components Debt & Equity in making decisions of raising & investing new capital.
This is very important to organization future.
8.0 Techniques of Capital Budgeting :
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8.1 Pay-back PeriodThe length of time required to recover the initial investment.
As such, shorter the payback period, the more desirable is the project. It is
simple method.

The limitations are :


It fails to consider the time value of money. The cash flows occurring at
different points of time can be added or subtracted only after suitable
compounding / discounting.
Ignores cash flows beyond the pay-back period. It favours projects
which generate substantial cash inflows in earlier years and
discriminates which bring substantial cash flows in later years.
It is a measure of projects capital recovery, not profitability.
8.2 Discounted Pay-back Period
To overcome the limitation of not considering the time value of money, in this
modified method cash flows are first converted into their present values & then
added to ascertain the period of time required to recover the initial outlay on the
project.
8.3 Net Present Value is the present value of cash inflows minus the present
value of cash outflows. In other words :
NPV (Net present value) =
= PVB (Present Value of Benefits) PVC (Present Value of Costs).
Net Present Value
Benefit vs. Cost
Acceptance
Positive
Benefit > Cost
Accept
Zero
Benefit = Cost
Indifferent
Negative
Benefit < Cost
Reject
In other words, it is the sum of present values of all cash flows positive or
negative that are expected to occur over the life of the project.
8.3 Internal Rate of Return is the discount rate that causes the present value of
benefits to equal the present value of the costs. In other words, IRR of a project
is the discount rate which makes its NPV equal to zero.
This is in common use. IRR is determined by trial & error method. NPV is
better than IRR being more realistic.
8.4 Modified Internal Rate of Return The difficulties of IRR is taken care of in
this method as follows :
Cash inflows are assumed to be reinvested at a reasonable rate.
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There is only one solution.


9.0 Project Rating Index helps to improve predictability of project
performance. Besides the benefits include detailed checklist of work planning,
facilitate risk assessment, pre-project planning, aid in communication between
participants, a training tool and benchmarking basis.

Capital Allocation Framework:


Capital is scarce & must be allocated across competing claims very judiciously. As
such the key responsibility of top management is concerned with capital allocation
decisions. A good corporate investment program can mean sustained growth;
failure to invest wisely can impede growth or even threaten companys survival.

Financing of Projects :
A project requires investment in land, plant & machinery, miscellaneous fixed
assets, technical know-how, distribution network, working capital, etc.
Capital Structure The two broad sources of finance available are shareholders
funds (equity) & loan funds (debt). The basic differences are as follows:

Equity
Shareholders have residual claim
on income & wealth of the firm.
Ordinarily has an indefinite life.
Investors enjoy facility to control
the affairs of the form.
Dividend paid is not a tax deductible
payment.

Debt
Creditor have fixed claim of interest
& principal payment.
Fixed Maturity.
Investors play a passive role.
Interest paid is a tax deductible
payment.

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


o Cost- Lenders expect a lower rate of return compared to equity shareholders
which is further reduced due to payment of tax. Debt is a cheaper but riskier
source of finance.
o Nature of Project If the assets are primarily tangible with resale / secondary
market option, debt finance is used more e.g. manufacturing industries.
If the assets are primarily intangible without resale / secondary market
option, debt finance is used less e.g. technical know-how.
The link between the nature of assets & use of debt finance is that lenders
are more willing to lend against tangible assets.

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


profit before interest & taxes / total assets which is influenced by following
factors:
1. Demand variability Other things remaining equal, the higher the
variability of demand for the products manufactured by the firm, the
higher is the business risk.
2. Price variability A project having higher degree of volatility for the
prices of its products is characterized by a higher degree of business
risk.
3. Variability of Input prices When input prices are highly variable,
business risk tends to be high.
4. Proportion of Fixed Operating costs - Other things being equal, if
fixed cost represent a substantial portion of total costs, business risk is
likely to be high. This is because when fixed costs are high, PBIT is
more sensitive to variation in demand.
Generally, the firm should be managed in such a way that the total risk borne by
the equity shareholders consisting of business risk and financial risk is not unduly
high. This implies that if the firm is exposed to high degree of business risk, its
financial risk should be kept low & vice-versa.
o Norms of Lenders The norms enforced by the lenders have a bearing on
the capital structure viz. Financial institutions earlier permitted debt-equity
ratio of 2 : 1. Now they allow debt-equity ratio 1 : 1.
o Control Considerations After deciding by the promoters own share of
investment, the extent of equity stake they want to have in a project has an
important bearing on its capital structure.
o Market Conditions If the equity market is buoyant & the equity shares can
be issued at a premium, the project may rely more on equity & vice-versa.
Reasons for Preferring use of Equity or Debt
Equity
Applicable tax rate is negligible
Business risk exposure is high
Dilution of control is not important
Assets of the project are mostly
intangible
Project with many growth options.

Debt
Applicable tax rate is high
Business risk exposure is low
Dilution of control is as issue
Assets of the project are mostly
tangible
Project with few growth options.

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Mean of Financing -Finance for a project can be obtained from variety of sources.
A firm can raise equity & debt capital from both public and private sources.
Capital raised from public sources is in the form of securities offered to public
through an offer document filed with SEBI. This can be traded on public
secondary markets.
Private capital may come from loans given by bank or financial institutions, etc.
Besides other sources may be Internal accruals like depreciation charges &
retained earnings, Working capital advance, etc.
Equity Capital represents ownership capital as equity holders collectively hold
the company. They enjoy the rewards & bear the risks of ownership. However their
liability is limited to their capital contributions unlike the liability of the owner in a
proprietary firm and the partners in a partnership concern. The terms followed are

Authorised Capital : The amount of capital that a company can potentially issue as
per its memorandum.
Issued Capital : The amount offered by the company to the investors.
Subscribed Capital : The part of the issued capital which is subscribed by the
investors.
Paid-up Capital : The actual amount paid-up by the investors.
Typically Issued, Subscribed & Paid-up capital are same.
Par value : The value stated in the memorandum & written in the share certificate.
It is generally Rs. 10 /Issue Price : The price at which the equity share is issued. Generally issue price &
par value are same.
Book value :
Paid-up equity capital + Reserves & surplus -- Intangibles
No. of outstanding equity shares
Market value : The price at which it is traded in the market. This price can be
easily established for a company which is listed on the stock market & actively
traded.
Rights of Equity Shareholders :
Right to Income the equity investors have a residual claim to the income of
the firm after satisfying the claim of all other investors. The income of the
equity shareholders may be retained by the firm or paid-out as dividends as
per decision of the Board of Directors.
Right to control Equity shareholders elect the Board of Directors & have
the right to vote on every resolution placed before the company. Scattered &
ill-organized, equity shareholders fail to exercise their collective power
effectively. Often the indirect control is weak & ineffective because of
indifference of most of the shareholders to attend annual general meeting
and rarely bother to cast their votes by post or proxy.
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Preference Capital - It is a hybrid of equity & debentures.


It resembles equity in the following ways
Preference dividend is payable only out of distributable profits. However it
is not an obligatory payment as it is within the discretion of directors.
Preference dividend is not a tax-deductible payment.
It resembles debenture in the following ways
Dividend rate is generally fixed.
Claim of preference shareholders is prior to the claim of equity shareholders.
Preference shareholders do not normally enjoy the right to vote.

Internal Accruals Consist of depreciation charges & retained earnings.


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

Debentures

Debentures are instruments for raising debt finance. Thus


debenture holders are the creditors of the company. Debentures often provide more
flexibility than term loans having greater choice with respect to maturity, interest
rate, repayment, etc.

Working Capital Requirement & its Financing


Working Capital There is always a time gap between sale of goods & receipt
of cash. Working capital is required for this period to sustain all the activities. In
case adequate working capital is not available for this period company may not be
in a position to purchase raw materials, pay wages & other expenses required for
manufacturing the goods to be sold. This time gap is termed operating cycle of
the business.
The working capital requirement consists of the following:
(a) Raw materials & components (indigenous as well as imported).
(b) Stocks of goods-in-process or work-in-process.
(c) Stocks of finished goods.
(d) Debtors.
(e) Operating expenses.
(f)
Consumable stores.
The principal sources of working capital finance are as follows:
(1) Advances provided by commercial banks.
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(2)
(3)
(4)
(5)
(6)
(7)

Trade credit or credit from suppliers.


Proceed from sale of assets
Public deposits.
Discounting bills of exchange.
Accruals & provisions.
Long-term source of financing.

The working capital requirements should be met from both short-term as well as
long-term sources of funds. The finance manager has to make use of both shortterm & long-term sources of funds in a way that the overall cost of working capital
is the lowest and the funds are available on time & for the period needed.
There are limits in obtaining working capital advances from commercial banks.
They are decided by :
(a) Lending norms followed by respective banks.
(b) Against current asset a certain amount of margin money pr0ovided.
Assessment of Working Capital Requirement:
Different methods are available
1.By estimation of different constituents of working capital individually.
2. Percent of Sales Approach based on experience and past data.
3. Operating Cycle Approach begins with acquisition of raw materials
& ends with collection of receivables. Duration of working capital or
operating cycle O = R + W + F + D C
where

R = Raw material storage period


=
W =

______Average stock of raw materials_____


Average raw materials consumption per day
Work in process period

Average work-in progress inventory____


Average cost of production per day

Finished stock storage period

___Average finished stock inventory___


Average cost of goods sold per day

D = Debtors collection period =

____Average book debts____


Average credit sales per day
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C = Creditors payment period or Credit period allowed to debtors


= _Average trade creditors_or Average total of outstanding debtors_
Average credit purchases per day or Average credit sales per day
Compute total number of operating cycles in a year by dividing 365 days by
number of operating days in a cycle. Compute average amount of working capital
requirement by dividing total operating expenditure in a year by number of
operating cycle in a year.

Working Capital Management


Working Capital = Current Assets Current Liabilities
Working Capital management is to manage Current Assets Current Liabilities
and interrelationship between them.
Working Capital should neither be inadequate or excessive. Current Assets should
be sufficient to cover Current Liabilities with reasonable safety margin. As such
different components of Working Capital are to be properly balanced
Liquidity shall be deceptive
If the proportion of inventories are very high due to slow moving or obsolete
inventory in the current assets.
If the proportion of accounts receivable is very high due to inability to
recover money from debtors in the current assets.
If a firm is maintaining a higher cash & bank balance then it is not making
profitable use of resources.

Working Capital Advance - by commercial banks represents the most


important source for financing current assets. It is provided by commercial banks
as follows :
Cash credits / Overdrafts A pre-determined limit for borrowing is
specified by the bank based on requirements & financial strength of the
company. Interest is charged on running balance & not on limit sanctioned.
This form of advance is highly attractive as borrower can draw the amount
in installments as & when required and repay as per availability of funds.
Loans These are advances of fixed amount to the borrower. The borrower
is charged interest on entire loan amount irrespective of the amount drawn.
Loans are payable either on demand or in installments.
Purchase / Discount of Bills The seller of goods draws the bill on
purchaser. On acceptance of the bill by purchaser, the seller offers it to the
bank for discount / purchase. When bank discounts / purchases the bill, it
release the funds to the seller. The bank presents the bill to the purchaser on
due date to receive the payment.
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Letter of Credit is an arrangement where a bank helps its customer to


obtain credit from suppliers where the bank undertakes the responsibility to
honour the obligation of its customers.

Miscellaneous Sources - In addition to the sources of finance mentioned, there


are several other ways in which finance may be obtained.
Deferred credit Payment for the purchases are made over a period of
time. When a deferred credit facility is offered, bank guarantee is
insisted to be furnished by the buyer.
Lease &hire purchase financethese are supplementary form of debt
finance.
A lease represents a contractual agreement whereby a lessor grants the lessee
the right to use an asset in return of periodic lease rental payments e.g. land,
buildings, machineries, etc.
The hirer pays regular hire-purchase installment over a specified period of
time. These installments cover interest as well as principal repayment. After
payment of last installment, the title of asset is transferred from hiree to hirer.
Unsecured Loans & Deposits provided by the promoters to fill the gap
between the promoters contribution required by financial institutions & the
equity subscribed by the promoters.
Deposits from public represent unsecured borrowings generally of 1 to 3
years duration.
Special schemes of Institutions to meet varied needs of industry designed
by different banks.
Subsidies and Sales tax deferments & exemptions Earlier central govt.
provided subsidies to industrial units located in backward areas which is
discontinued. However, to attract industries state govt. continued with
subsidies as well as incentives in the form of sales tax deferments &
exemptions.
Short term loans from Financial Institutions is provided to companies with
good track records.

Raising Venture Capital


o A new company unable to tap public financial market may seek venture

capital.
o Venture capital means funds made available for start-up firms and small
businesses with exceptional growth potential.
o Venture capital is money provided by professionals who alongside
management invest in young, rapidly growing companies that have the
potential to develop into significant economic contributors.
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o Such capital is provided by venture capital funds which finance untried


company having promising prospects. It represents financial investment in a
risky proposition in the hope of earning high rate of return.
Examples of Venture Capital Funds in India :
1. Promoted by Central Govt. Viz. Industrial Finance Corporation of India
(IVCF), Small Industry Development Bank of India (SVCL).
2. Promoted by State Govt. Viz. Gujarat Venture Finance Ltd.
3. Promoted by Public Sector Banks Viz. SBI Capital Market Ltd., Canbank VCF.

Venture capitalists generally


Finance new and rapidly growing companies.
Purchase equity securities.
Assist in development of new products and services.
Add value to the company by active participation.
Venture Capital Features
Long time horizon.
Lack of liquidity.
High risk.
Equity participation.
Participation in management.

Raising Capital in International Markets


Due to globalization, Indian firms can raise capital from international
markets.
Many good companies get listed on stock exchanges indirectly using
American Depository Receipts or Global Depository Receipts.
These receipts, which are traded like ordinary stocks, are called Depository
receipts. Each receipt amounts to a claim on the predefined number of
shares of that company.

Cost of Project represent total outlay associated with a project


supported by long term funds which broadly are as follows :
Land & site development
Building & civil works
Plant, machinery & other fixed assets
Technical know-how & engineering fees
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Expenses on foreign experts & training of Indian employees abroad, if


applicable
Preliminary, capital issue and pre-operative expenses
Contingency
Margin money for working capital
Initial cash losses

Estimates of Sales & Production Sales & Production may be estimated


together as they are closely related. The starting point for profitability projections
is the forecast of sales revenue.
It is advisable to assume that capacity utilization will be lower in the first year &
gradually reach the maximum level in subsequent years.

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


Materials cost
Utilities cost
Labour cost
Factory overheads

Profitability Projections The profitability projections or estimates of


working results may be prepared along the following lines:
A. Cost of production (Cost of materials, labour, utilities & overheads)
B. Total administrative expenses (Remuneration to directors, communication &
office materials, insurance, taxes, etc.)
C. Total sales expenses (Packing, forwarding, sales promotion & advertising)
D. Royalty & know-how payable
E. Total cost of production (A+B+C+D)
F. Expected sales
G. Gross profit before interest (FE)
H. Total financial expenses (Interest on loans, bank guarantee commission,etc.)
I. Depreciation
J. Operating profit (GHI)
K. Other income
L. Preliminary expenses written off
M. Profit / loss before taxation (J + KL)
N. Provision for taxation
O. Profit after tax (MN)
Less dividend on : (1) Preference capital; (2) Equity capital
P Retained profit
Q Net cash accrual (P + I + L)

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Projected Cash Flow Statement The cash flow statement shows the
movement of cash into & out of the firm and its net impact on cash balance within
the firm.

Projected Balance Sheets The balance sheet shows the balance in various
asset & liability accounts reflecting the financial condition of the firm at a given
point of time.

Format of Balance Sheet prescribed by companies act


Liabilities
Share capital
Reserves & surplus
Secured loans
Unsecured loans
Current liabilities & provisions

Assets
Fixed assets
Investments
Current assets, loans & advances
Misc. expenditures & losses

The liabilities side of the balance sheet is the sources of finance employed by
the business.
Share capital paid-up equity & preference capital.
Reserves & surplus accumulated retained earnings shown in different accounts
like capital reserve, investment allowance reserve & general reserve.
Secured loans Borrowings of the firm against security like debentures, term loans
from financial institutions & loans from commercial banks.
Unsecured loans Borrowings of the firm without specific security like fixed
deposit from public & unsecured loans from promoters.
Current liabilities are obligations which mature in near future generally within a
year. These obligations arise from items which enter the operating cycle like raw
materials payment, accrual of wages, rentals, etc.
Provisions include provision for tax, provident fund, pension & gratuity,
proposed dividends, etc.
The assets side of the balance sheet shows how funds have been used in the
business.
20

Fixed assets Tangible resources for producing goods & services. Shown as
original cost less depreciation.
Investments Financial securities owned by the firm.
Current assets, loans & advances Cash, debtors, inventories of different kinds,
loans & advances made by the firm.
Miscellaneous expenditures & losses Outlays not covered in the described asset
accounts & accumulated losses, if any.
For preparing projected balance sheet at the end of year n+1, the following
information are required:
o
o
o
o
o
o
o

The balance sheet at the end of year n


Projected income statement & distribution of earnings for year n+1
Sources of external financing proposed to be tapped in year n+1
Proposed repayment of debt capital during year n+1
Outlays & disposal of fixed assets during year n+1
Changes in level of assets during year n+1
Cash balance at the end of year n+1

UNIT II

21

Market & Demand Analysis : Conduct of Market Survey, Characterization of


Market, Demand Forecasting, Uncertainties in Demand Forecasting, Market
Planning.
Technical Analysis :
Manufacturing Process / Technology, Technical
Arrangements, Product Mix, Plant Capacity, Location & Site.
________________________________________________________________
This should be carried out in a systematic & orderly manner. The steps of Project
Analysis are as follows:
Estimate the Potential size of the Market or Services
Supply Demand Gap
Patterns of Consumption Growth
Income & Price Elasticity of Demand
Composition of Market
Nature of Competition
Availability of Substitutes
Reach of Distribution Channels

Conduct of Market Survey:


Secondary information needs to be supplemented with primary information
gathered through market survey to keep a track on latest changes or developments.
The market survey can be
o Census Survey where entire population is covered. Census survey is done
when goods are used by small numbers, otherwise it may be prohibitively
costly & infeasible.
o Sample Survey is popular for market survey practice where a sample of
population is contacted to gather relevant information. Larger the sample
size, the reliability is higher.
Steps in sample survey broadly are
1. Define the target population.
2. Select the sampling scheme & sample size.
3. Develop the questionnaire.
4. Recruit & train the field investigators.
5. Obtain information as per questionnaire from respondents.
6. Scrutinize the information gathered.
7. Analyze & interpret the information.

Characterization of Market:

22

Based on the information gathered from secondary sources & through market
surveys, the market for the products / services may be described in terms of the
following
Effective demand in the past & present.
Breakdown of demand.
Price
Methods of distribution & sales promotion.
Consumers
Supply & competition
Government policy

Demand Forecasting:
The future demand may be estimated after collecting information about various
aspects of the market & demand from primary & secondary sources. A wide range
of forecasting methods are available to the market analysts as follows:
1.0 Qualitative Methodsbased on the views of experts e.g. Delphi method,
etc.
2.0 Time Series Projection Methodsgenerate forecasts on the basis of analysis
of historical time series e.g. Trend projection method, Exponential
smoothing method, Moving average method, etc.
3.0 Causal MethodsChain ratio method, Consumption level method, End use
method, etc.

Uncertainties in Demand Forecasting:


Demand forecasting are subject to error & uncertainty arising broadly from
following sources
Data about past & present market may be vitiated by Lack of
standardization, Few observations, Influence of abnormal factors, etc.
Methods of forecasting may face the limitations of Inability to handle
unquantifiable factors, Unrealistic assumptions, Excessive data
requirements, etc.
Environmental change may arise due to Technological change, Shift in
Govt. policy, Developments on the international scene, Discovery of new /
alternative source of materials, etc.

Market Planning: A marketing plan usually has following components


Current marketing situation dealing with different dimensions of the current
situation like Market situation, Competitive situation, Distribution situation,
macro-environment, etc.
23

Opportunity & issue analysis covering SWOT.


Objectives have to be clear-cut, specific & achievable.
Marketing strategy covers target segment, positioning, product line, price,
distribution, sales force, sales promotion & advertising.
Action plan is implementation of the strategy.

Technical Analysis
Manufacturing Process / Technology: Out of different alternatives available,
Choice of technology is influenced by a variety of considerations

Plant capacity
Principal inputs
Investment outlay & production costs
Proven technology
Product mix
Latest developments
Ease of absorption

Technical Arrangements: to obtain the technical know-how needed for the


proposed manufacturing process.

Product Mix: choice of product mix is guided by market requirements. Flexibility


with respect to product mix enables the firm to alter the production in response to
changing market conditions.

Plant Capacity: refers to the quantum of the item that can be manufactured
during a given time period. Several factors as follows have a bearing on the
capacity decision
Technological requirements minimum economic size especially in
chemical plants.
Input constraints basic raw materials, utilities like power, water, etc.
Investment cost
Market conditions
Resources of the firm both managerial & financial
Government policy

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

24

A perfect location model is the one where the total cost i.e. raw material
transportation cost, production cost and distribution cost for the final product is
minimized.
Availability of infrastructure
Availability of power, transportation, water and communications should be
carefully assessed.
Labor situation
Availability of labor
Prevailing labor rates
Labor productivity
Degree of unionization
Government policies
In case of public sector projects, location is directly decided by the govt..
In case of private sector, location is influenced by certain govt. restrictions and
inducements.
Other factors
Climate conditions
General living conditions
Ease in coping with pollution
UNIT III
Project Management : Forms of Project Organization, Project

Planning, Project Control, Human Aspects of Project Management.


Network Technique : Development of Project Network, Time
Estimation (Simple Practical Problems with EST, EFT, LST, LFT, Total
Float), Determination of Critical Path, Scheduling when Resources are
limited, PERT Model, CPM Model (Simple Practical Problems of
Crashing), Network Cost System.
Project Review & Administrative Aspects : Control of In-progress
Projects, Post Completion Audits.
__________________________________________________________
and a Finish
A time frame for Completion
Continuity
Involvement of several BASIC CHARACTERISTICS OF A PROJECT :
A Start People
A limited set of Resources
25

Sequencing of Activities

Forms of Project Organization:


The traditional form of organization is quite appropriate for handling established
operations characterized by continuous flow of repetitive work with each
department attending to specific work.
However the traditional form of organization is not suitable for project
management due to the reasons
o Project is a non-repetitive, non-routine undertaking often associated with
many uncertainties.
o Relationships in a project setting are dynamic, temporary & flexible.
o Project requires co-ordination of the effort of the persons drawn from
different functional areas working under time & cost pressures.
As such, there is a need for entrusting an individual (Project Manager or
Coordinator) or group with the responsibility for integrating the activities of
various departments & external agencies involved in the project work.
The project organization may be of following forms depending on the authority
given to the person responsible for project execution.
Line & Staff Organization A project coordinator is appointed with the
responsibility of coordinating the work of the people in the functional
departments. He acts essentially in a staff position to facilitate coordination
of line management. The project coordinator does not have authority &
direct responsibility of line management. His influence would depend on his
professional competence, closeness to top management & persuasive
abilities. This form of organization is not suitable for large projects but may
employed for small projects.
Divisional Organization A separate division headed by the project
Manager is set up to implement the project. The project manager has full
line authority over these personnel. This type facilitates the process of
planning & control, better integration of efforts & commitment of project
related personnel. This form, however, may entail inefficient use of the
resources of the firm due to duplication of efforts.
Matrix Organization This seeks to achieve the twin objectives of efficient
use of resources & effective realization of project goals. Here the personnel
working on a project have responsibility to their functional superiors as well
as to the project manager i.e. the authority is shared between the project
manager & functional managers. Thus the project manager integrates the
contribution from various functional departments towards realization of
project objectives. This is most popular form in execution of large projects.

Project Planning:
26

Planning is a vital aspect of management which serves several important functions Basis of organizing different works of the project & allocating
responsibilities to individuals.
Means of communication & coordination between all involved in the
project.
Induces people to look ahead.
Instills a sense of urgency & time consciousness.
Establishes the basis for monitoring & control.
Comprehensive project planning broadly covers the following areas
Detail planning of the project work with break down of activities. The
activities should be properly scheduled & sequenced.
Manpower planning Manpower required in different phases of the project
must be estimated realistically & the allotment of responsibilities.
Financial planning to control the expenditure in time phased manner as per
budgetary estimates & provision.
Communication, reporting & information planning for proper
implementation & monitoring / control of the project.
Tools of Planning Bar charts, Network techniques, etc.

Project Control:
Control becomes the dominant concern of the project manager after the project is
launched. It involves a regular comparison of performance against targets, search
for causes of deviation & initiate corrective measures or check variances. There are
different approaches for project control adopted based on requirements &
suitability, some of which are furnished
Variance Analysis This is a traditional approach involving comparison of
the actual cost with the budgeted cost to determine the variance. This has
the shortcoming of backward looking rather forward looking.
Performance Analysis This may be based on (a) budgeted cost for work
scheduled & work performed, (b) actual cost of work performed,
(c) Additional cost for completion, etc.

Human Aspects of Project Management:


To achieve satisfactory human relations in project setting, the project manager
must successfully handle problems & challenges relating to (i) Authority,
(ii) Orientation, (iii) Motivation & (iv) Group functioning.
27

Pre-requisites for Successful Implementation:


Due to time & cost over-runs, projects tend to become uneconomical, resources are
not available to support other projects & economical developments are adversely
affected. The important areas to improve prospects of successful completion of
projects are
o Adequate formulation.
o Sound project organization.
o Proper implementation planning.
o Timely availability of funds.
o Judicious tendering & procurement.
o Efficient contract management.
o Effective monitoring & control.
Network Technique
Once the project is selected, the focus shifts on implementation. This involves
completion of numerous activities by employing various resources men,
machines, materials, money & time.
Network - A network is constructed to represent a project graphically.
It shows the position of various events & activities from start to finish.
Network Techniques broadly comprises of PERT (Program Evaluation & Review
Techniques) & CPM (Critical Path Method). These are essentially time oriented.
The main purpose of network analysis is to find the critical path i.e. sequence of
activities with the longest duration and to find the float associated with each noncritical activity.
Objectives of Network Techniques :
Help in planning, scheduling & controlling projects.
Creates & establishes relationship between different activities of the
projects.
Helps in reducing total time & cost of the projects.
Complete the project within the stipulated period & cost.
Optimum utilization of available resources.
Avoid delays & interruptions, develops discipline & systematic approach.
Steps :
Breakdown of project activities.
Estimating time requirement for each activity from similar projects or from
experience.
28

Establishing relationship between precedent, subsequent & concurrent


activities.
Construction of network diagram as per sequence.
Network Logic :
I. Event An event is the beginning or completion of a task. Thus event takes
place at a particular instant of time & does not consume time or
resources.
1 have a distinct number.
Each event should
2

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


project represented by an arrow. As such activities occur between all events and
link consecutive events in a network by an arrow. Activities consume time &
resource.
There will be only one activity between 2 events.
Each activity must have a preceding & succeeding events. Not more than one
activity can have same preceding & succeeding events.
Predecessor Activity Activities that must be completed immediately prior
to the start of another activity.
Successor Activity - Activities that can not be started until one or more of
the other activities are completed but immediately succeed them.
Concurrent Activity - Activities that can be accomplished simultaneously.
Dummy Activity - Activities that consume no time or resources.
When two parallel activities would have the same head & tail events viz.
consider a project having 5 jobs A, B, C, D, E and suppose that B, C, D can
all start as soon as A is complete and job E has to wait until B, C, D are
complete. The logical relationship among jobs & with event numbers are
shown in the figure:

29

D-1
B
A
1

D-2

1. Slack is the freedom for scheduling or to start any event. An event for
which slack is zero is critical event.
Float - Critical activities have no spare time. However, for non-critical
activities certain amount of spare time is available which is called Float.
This may be total, free or independent .
Total Float signifies the maximum delay that can be permitted in the
completion of activity without affecting project completion.
Free Float is the time an activity can be rescheduled without affecting
the commencement of succeeding activity.
Independent Float is the time by which an activity can be rescheduled
without affecting both preceding & succeeding activities.
Presence of float in a project signifies under utilization of resources and
indicates inherent flexibility in the process.
Features of Network :
1. In network diagrams arrows (
) represent activities & circles (O)
represent the events. Single activity can be represented once only in
the network & events should not be repeated.

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

3. Interdependency: Before an activity can be undertaken, all preceding


activities must be completed.
4. Designed on the basis of logical, technical & interaction between
different activities of the project.
30

5. The tail of the arrow represents the starting point of time of the
activity & arrow head represents completion of time of the activity.
6. There should be no loops in the project network.
Time Estimates : Generally 3 time values are obtained for each activity.
Optimistic time (to) - shortest possible time to complete the activity if
everything goes well i.e. without provision for any delay or setbacks.
Most likely time (tm ) - is the best estimate of time which is likely to be
accomplished.
Pessimistic time (tp) - longest time to complete the activity under
adverse conditions i.e. everything went wrong excluding force majeure
situation.
to + 4 t m + t p
Expected activity time (te ) - is computed te = ---------------6
Earliest start time (EST) of an activity is the earliest finish time of
preceding activity as network logic indicates that an activity cannot
commence until the preceding event is completed.
Earliest finish time (EFT) equals the earliest starting time plus duration
of activity.
Latest starting time (LST) is the latest finishing time minus activity
duration.
Latest finish time (LFT) is the maximum time allowed to finish an
activity.
PERT NETWORK
This is a diagram showing the steps needed to reach a stated objective. It
depicts events, activities, interrelation-ship and recognizes progress to be
made in one activity before subsequent activities can begin. Thus PERT
network is a flow chart of independent events & activities each of which
must be completed to achieve project objective. This is used with
uncertain time estimates.

O----O----O----O
CRITICAL PATH METHOD
The comparison of duration of different paths identifies a path whose
duration is the longest. The path with longest duration of the project is
31

called the critical path & the activities are known as critical activities.
Critical activities have no float associated with them. If any activity on
this path is delayed, then entire project is affected. The critical path helps
to identify a set of activities & events which are critical and as such must
be carefully monitored & controlled.
The critical path is shown by thick or red or double line for clear
differentiation.
Characteristics
Every network has a critical path.
It is possible to have more than one critical path.
Critical path connects first to last events.
Critical path is the longest path from the beginning event to the end
event.
The minimum time required for completing the project is the
duration of critical path.
Earliest starting time is same as latest starting time
Earliest finishing time is same as latest finishing time
Distinction between PERT and CPM
The basic differences between the two techniques are summarized below :
Sl.No.
PERT
CPM
A
probabilistic
model
with
uncertainty
in
A
deterministic
model
with certainty in
1.

2.
3.
4.
5.

activity duration. The duration of each


activity is computed from multiple time
estimates.
This is event oriented.
It is applied for widely planning &
scheduling
research
programs
&
developing projects.
PERT analysis does not consider cost.

activity duration
experience.

based

upon

past

This is activity oriented.


It is used for construction projects &
business problems.

CPM deals with cost of project schedules


& their minimization by crashing.
This helps the manager to schedule & This places dual emphasis to trade-off
coordinate various activities to complete between project time & additional cost.
the project on scheduled time.

Crashing of a Project:
Cost plays an important role in any project in addition to time management. Time
cost relationship is of great significance in project management.
Crash time is the minimum possible time in which the activity can be completed
and the cost associated with this time is the crash cost.
The project costs consist of both direct & indirect costs.
32

Direct costs can be linked directly with the activity viz. labor, material, equipment
rental charges, etc. Generally increasing the direct activity cost e.g. working overtime by labor force can reduce the activity duration.
Indirect costs are overhead costs, interest charges, loss of revenue / benefit due to
late completion of the project, etc.
An optimal project completion time will be the time for which sum of the direct &
indirect costs are minimum. It can be observed that shortening the duration leads to
increase in direct cost but decrease in indirect costs. The strategy will be justified
only when there is net savings.
Actual time-cost relationship could be of any shape but with the assumption of
linearity for an individual activity, cost of crashing an activity by unit time is
Crash Cost Normal Cost__
Normal Time Crash Time
Procedure for Reducing Project Completion Time:
1. Identify all critical paths.
2. Compute for each activity on critical path, cost of reducing activity time
by one unit
Crash Cost Normal Cost__
Normal Time Crash Time
2. Consider the activity where the cost of crashing by unit time is
minimum. However no activity can be reduced lower than the crash
time. If there is at least one critical path on which none of the activities
can be crashed then no further reduction of project completion time is
possible.
Network Cost System : The techniques of PERT & CPM overlooks the cost
aspects which are equally important. To provide a vehicle for cost planning &
control of projects, the network cost system was developed.
The costs are planned, measured, analyzed & controlled in terms of project
activities.
Actual cost or cost incurred till date can be obtained by summing up costs for
various activities as costs are recorded activity-wise.
Value of work completed till date can be obtained by multiplying % work
completed with budgeted cost.
Cost over-run when the cost incurred is more than value of work done.
33

Cost under-run when the cost incurred is less than value of work done.
Actual cost --- Value of work done
Cost over-run (under-run) to date:-------------------------------------------------- x100%
Value of work done
Project Review & Administrative Aspects:
A project is monitored during implementation phase so that time & cost over-runs
are minimized. After a project is completed & commissioned, the performance is
reviewed to check whether it is line with expectations.

Control of In-progress Projects


In spite of lot of efforts in selecting capital projects, things may go wrong in the
implementation phase. This is reflected from frequent cost & time over-runs
witnessed in practice. Hence it is necessary to exercise strict control on in-progress
capital projects. There are two aspects of control :
o Establishment of Internal Control Procedures
o Use of Regular Progress Reports

Post Completion Audits


An audit of a project after it has been commissioned is referred to as post
completion audit. It provide a documented experience valuable in improving future
decision making with respect to capability & quality of individuals, the reasons of
generations of various pitfalls & ways adopted to overcome, etc.
Net Income
Commonly, book ROI is used which is ----------------------------------

Book Value of Assets

34

UNIT IV
Risk and Uncertainty Analysis : Using Sensitivity, Simulation, Decision &
Other Techniques.

--------------------------------------------------------------------------------------Risk : Risk is inherent in every business with variation. More so in the Capital
Budgeting decisions as they involve costs & benefits extending over a long period
of time during which many changes may occur in unanticipated ways.
In view of differences in risks in different types of projects, variations in risk are to
be evaluated. Different techniques have been suggested, but no single technique
can be deemed as best in all situations.
Risk analysis is one of the complex and multi-faced phenomenon of capital
budgeting.
Sources / Types of Risk :
Stand-alone Risk represents the risk of a project when viewed in isolation.
Corporate Risk reflects the contribution of a project to the risk of the firm.
Project Specific the earnings & cash-flows of the project may be lower
than expected due to estimation error or poor quality of management.
Competitive Risk - the earnings & cash-flows of the project may be affected
by unanticipated actions of the competitors.
Industry specific Risk Unexpected technical developments and regulatory
changes which will have an impact on the earnings & cash-flows of the
project.
Market Risk Unanticipated changes in macro-economic factors like GDP,
Growth rates, Interest rates & Inflation have an impact on all projects in
varying degrees.
International Risk - the earnings & cash-flows of the project may be
different than expected due to change in exchange rate & political factors.
The techniques suggested to handle risk in capital budgeting may be divided into 2
categories
1.0 Stand-alone risk of a project
2.0 Risk of a project in the context of firm or market.

Techniques of
Risk Analysis

Stand-alone Risk

Corporate Risk
Analysis

35

Sensitivity
Analysis

Market Risk
Analysis

Simulation

Decision & Decision


Tree Analysis

Stand-alone risk can be further sub-divided to :


1.1 Sources, measures and perspectives on risk ::
Sources on risk project specific risk (due to estimation of error & quality
of Management) ; competitive risk (actions of competitors) ; industry
specific risk (technological innovation & Regulatory changes) : market risk
(changes in GDP growth rate, interest & inflation) ; international risk
(variation in exchange rate & political).
Measures on risk range, standard deviation, coefficient of variation &
semi-variance).
Perspectives on risk viewed in isolation.
1.2 Break-even analysis :: the production of minimum quantity to avoid loss or
no-profit & no-loss level of production.
1.3 Managing risk :: risk reduction strategies involving cost are assessed in a given
situation about the profitability.
1.4 Sensitivity Analysis :
The viability of a project in future must be assessed when some variables like sales
or investments deviates from the expected values. To do this vary one variable at a
time in both positive & negative direction and check the impact on NPV. Thus,
sensitivity analysis analyze the sources of risk.
The merits of sensitivity analysis are :
It shows how robust or vulnerable a project is to changes in values of the
underlying variables.
If the NPV is highly sensitive to changes in some factor, then process of
containing the variability of that critical factor should be explored.
36

It takes care of normal concern of project evaluators.


The sensitivity analysis suffer from several shortcomings :
It ignores probabilities and consider only one variable is changed at a time.

However, in reality more than one variable may change at a time. A decision
maker may not feel confident if all the factors are not combined into a single
analysis with probabilities assigned.
The interpretation of results are subjective i.e. same sensitivity analysis may
lead one decision maker to accept the project while another may reject it.
1.5 Simulation :
This gives a better comparison of risk and return. The simulation is done with the
help of special software in a computer being a complex method.
The steps involved in simulation analysis are as follows :
1. Establish a relation between the NPV with project parameters & the variables.
2. Forecast various outcomes & assign probabilities to them.
3. Decide number of iterations (simulation runs) to be carried out.
4. For each iteration select different values for forecast parameters.
5. Calculate the NPV for the values of parameters selected in each run.
6. Repeat steps 4 & 5 for number of iterations selected.
7. Now one NPV is available for each run. Plot the frequency distribution of
each NPV.

Frequency

Net

Present

Value

[Page 388 Patel]


1.6 Decision :

37

Decisions are very important in all aspects of life. In various situations in life, we
have to choose between different alternatives available sometimes even with
incomplete information. A wrong decision taken in haste without detail & longterm considerations may lead to disaster. As such before arriving at decisions all
pros & corns are examined from all possible angles to avoid future problems.
The simulation method gives a profile of the outcome with due recognition of
probabilities. But decision rules are not given. However, if the expected return &
standard deviation are calculated, then decision guidelines can be drawn.
From the above graph, the following decisions may be considered
(1) ProjectB seems to have clear edge over ProjectA. B has a higher expected
value & almost the same dispersion (or standard deviation) as compared to A.
(2) Between ProjectsB & C, the risk perception of the decision maker will have a
greater effect on the choice. ProjectC is less risky though giving an expected
NPV similar to B.
Based on the types of information available, the decision environment can be
classified as follows :
Decision making under certainty Complete & accurate knowledge of the
outcome of each alternative.
Decision making under un-certainty Multiple outcomes for each
alternatives can be identified without the knowledge of probability.
Decision under risk - Multiple outcomes for each alternatives can be
identified but with the knowledge of probability.
Decision Tree :
It consists of network of nodes, branches, probability estimates & pay-offs. There
are two types of decision trees deterministic & probabilistic. These can further be
divided into single stage & multi stage trees.
Decision tree diagram is useful for portraying the inter-related, sequential & multi
dimensional aspects of any major decision problem.
2.0 Corporate risk & Market risk it is analyzed on following groups
2.1 Port folio related risk measures : the mean variance portfolio model is most
widely used which is defined by the variance or standard deviation
of the probability distribution of portfolio returns.
The return of investment is generally measured as a holding period return
38

Cash flow during the period + ( Ending value Beginning value)


= ------------------------------------------------------------------------------------------Beginning value
2.2 Capital asset pricing model (CAPM) : this examines the relationship between
risk and return in the capital market if investors behave in conformity with the
prescription of portfolio theory.
CAPM is concerned with 2 set of questions
1.(a) What is the appropriate measure of risk for an efficient portfolio ?
(b) What is the relationship between risk & return for an efficient portfolio ?
2.(a) What is the appropriate measure of risk for an inefficient portfolio ?
(b) What is the relationship between risk & return for an inefficient portfolio ?

39