PM Chapter-2

Chapter 2: Project Appraisal 17
Chapter-02
PROJECT APPRAISAL
Outline Syllabus
Market Appraisal - information required for market and demand analysis -
demand forecasting Technical appraisal - material and inputs - machinery and
equipment - structures and civil works - work schedules, Financial appraisal
-cost of project and means of financing - profitability - assessing tax burden
- financial projections. Economic appraisal - measuring cost and benefits,
appraisal criteria -social costs benefit analysis.
2.01 MARKET APPRAISAL

Appraisal means valuation of property (ie. real estate, a business, an antique) by the estimate of
an authorized person. In order to be a valid appraisal, the authorized person will have a
designation from a regulatory body governing the jurisdiction the appraiser operates within.
Market Appraisal is a professional opinion, usually written, of the market value of a property,
such as a home, business, or other asset whose market price is not easily determined. Usually it is
required when a property is sold, taxed, insured, or financed. Market appraisal considers the
following aspects of the market for the project:
Aggregate future demand
Market share
Current and future competition
Location and accessibility of consumers
Technological scenario/obsolescence
Possible pricing options
What do you mean by appraisal?

Write short notes on Market Appraisal. BBA (Professional) 2009
2.02 PROJECT FEASIBILITY STUDY

18 Project Management
The term feasibility study is used as a convenient description for the output for the work
done; users of this toolkit should not apply preconceived notions of what a feasibility study
consists of. Some of the definition are given below.
According to Eric Mc Connell, A Project Feasibility Study is an exercise that involves

documenting each of the potential solutions to a particular business problem or opportunity.
Feasibility Studies can be undertaken by any type of business, project or team and they are a
critical part of the Project Life Cycle.
According to Georgakellos, D. A. & Marcis, A. M., The feasibility study is an evaluation

and analysis of the potential of a proposed project which is based on extensive investigation
and research to support the process of decision making.
A feasibility study may be necessary for a variety of projects, including many business studies
for the expansion or continued operation of a company or small business, as well as other types of
proposed projects like public works initiatives.
What is project feasibility study? BBA (Professional) 2009, 2011, 2012,1014
2.03 PROJECT RATING INDEX

Definition: The Project Rating Index (PRI) for building projects is a powerful and simple tool
that helps meet this need by offering a method to measure project scope definition for
completeness. The PRI is a simple and easy-to-use tool for measuring the degree of scope
development on building projects. When a firm evaluates a large number of project ideas
regularly, it may be helpful to streamline the process of preliminary screening. For this purpose, a
preliminary evaluation may be translated into a project rating index.
Steps: The steps involved in determining the project rating index are as follows:
1. Identify factors relevant for project rating
2. Assign weights to these factors (the weights are supposed to reflect their relative importance)
3. Rate the project proposal on various factors, using a suitable rating scale.(Typically a 5-point
scale or a 7-point scale is used for this purpose)
4. For each factor multiply the factor rating with the factor weight to get tin- factor score
5. Add all the factor scores to get the overall project rating index
Following table illustrates the determination of the project rating index. Once the project rating
index is determined, it is compared with a pre-determined hurdle value to judge whether the
project is prima facie worthwhile or not
determination of the project rating index
Factor Factor Rating Factor
VG G A P VP
Weight Score
5 4 3 2 1
Input availability 0 25 0.75
Technical know-how 0.10 0.40
Reasonableness of cost 0.05 0.20
Adequacy of market 0.15 0.75
Complementary relationship with other products 0.05 0.20
Stability 0.10 0.40
Dependence on firm's strength 0.20 1.00
Consistency with governmental priorities 0.10 0.30
Rating Index 4.00
What is Project Rating Index (PRI)? BBA (Professional) 2010

How would you develop a project rating index? BBA (Professional) 2010
Discuss how a project rating index may be developed. BBA (Professional) 2008
What are the steps involved in determining project rating index?
2.04 SCHEMATIC DIAGRAM OF FEASIBILITY STUDY

Feasibility is the first stage of the project. The project could be in greenfield or in brownfield
areas. Due to irreversibility and huge outlays involved, the more the time spent on project
feasibility study, the better is the result.
Schematic diagram
There are three broad phases in capital budgeting (expenditure) decision. The feasibility study is
concerned with planning, analysis, and selection. These include market, technical, financial,
economic and ecological analysis. A schematic diagram would help to understand the study
better.
Flowchart for project feasibility studies: -
Generation of ideas
New ideas or creativity is the ability to combine, or synthesize available information and
experiences to see new patterns and possibilities. Ideas can be generated by:
Any individual with expertise skill in a specific area who feels that he can contribute to
the creation of a new product.
Associates, who encourage him, show a willingness to join him and endorse his ideas.
Monitoring the basic infrastructure, economy, technology, competition sector, supplier
sector etc.
An analysis of the performance of existing industries.
A study of the input/output of various industries.
A review of the imports and exports.
Screening of ideas
By using the processes described in the preceding section, a company can develop a long list of
project ideas. We need some preliminary screening to shortlist ideas that hold promise that are
remotely possible. For this, we need to follow the following steps:
Compatibility with the promoter
Consistency with the Government priorities
Availability of inputs
Adequacy of the market
Reasonableness of cost
Acceptability of risk level
A study of plan outlays and Government guidelines
After the preliminary screening, we have to focus on the profit potential, latent in these ideas.
Michael Porter has given a theoretical base, which is widely accepted and used, by consulting
agencies while evaluating projects.
Single out the big ticket project

It is often taken for granted that there is an abundance of profitable projects exists. The fact,
however, is that there are various local rules and regulations, as well as entry barriers, which
create imperfections in the market. Before attempting a feasibility study, a quick examination of
market, technicalities and financials is advisable.
Present a schematic-diagram of the feasibility study of a project.
BBA (Professional) 2008
2.05 FACTS OF PROJECT FEASIBILITY STUDY

The important facts of Project Feasibility Study are as follows :
1. Market analysis of a project
2. Technical analysis of a project
3. Financial analysis of a project
4. Economic analysis of a project
5. Ecological analysis of a project
1. Market analysis: Market analysis is associated primarily with two questions:
o What would be the collective demand of the planned product / service in future?
o What would be the market share of the project under evaluation?
To answer the above questions, the market analyst needs a broad variety of information and
suitable forecasting methods.
2. Technical analysis: Examination of the technical and engineering characteristics of a project

needs to be done repeatedly when a project is made. Technical analysis seek out to decide
whether the fundamentals for the successful commissioning of the project has been considered
and reasonably good options have been made with respect to location, size, process etc.
3. Financial analysis: Financial analysis tries to ascertain whether the planned project will be
financially feasible in the sense of being able to meet the saddle of servicing debt and whether the
planned project will convince the return expectations of those who provide the capital. Cost,
profitability, financing, break-even point, cash flow, level of risk and financial position are the
feature that have to be looked into while conditioning financial appraisal.
4. Economic analysis: Economic analysis is also referred to as social cost benefit analysis and is
concerned with evaluating a project from the larger social point of view. In such a judgement the
focus is on the social costs and benefits of a project which may usually be different from its
economic costs and benefits.
5. Ecological analysis: In recent years, environmental concerns have assumed a great deal of
importance and rightly so. Ecological analysis should be done particularly for major projects
which have significant ecological inference like plants and irrigation schemes, and environmental
polluting industries like bulk drugs, chemicals and leather processing.
Assess different facts of feasibility study in project analysis.
BBA (Professional) 2009, 2011,2012,2014
2.06 SOURCES OF POSITIVE NET PRESENT VALUE

Net present value (NPV) is the present value of an investment's expected cash inflows minus the
costs of acquiring the investment.
NPV = (Cash inflows from investment) (cash outflows or costs of investment)
A positive net present value means a better return.
It appears that there are six main sources of positive Net Present Value of a projects which are as
follows:
Economies of scale
Product differentiation
Cost advantage
Marketing reach
Technological edge
Government policy
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. When substantial economies of
scale are present, the existing firms are likely to be large in size. The more pronounced the
economies of scale, the greater the cost advantage of the existing firms.
In order to exploit the economies of scale, cost decrease. For this cash inflows from investment
become greater than cash outflows or costs of investment and this case NPV become positive.
2. Product Differentiation: Effective advertising and superior marketing, exceptional service,

innovative product features, high quality product of a firm can create of positive Net Present
Value.
3. Cost Advantage: If a firm can enjoy cost advantage vis-a-vis its competitors, it can be
reasonably assured of earning superior returns. Cost advantage may stem from one or more of the
following:
Accumulated experience and comparative edge on the learning curve
Monopolistic access to low cost materials
A favorable location
More effective cost control and cost reduction
4. Marketing Reach: A penetrating marketing reach is an important source of competitive

advantage. For this cash inflows from investment become greater than cash outflows or costs of
investment and this case NPV become positive.
5. Technological Edge: Technological superiority enables a firm to enjoy excellent returns. A

firm substantially outperformed their competitors because of their technological strength. For this
cash inflows from investment become greater than cash outflows or costs of investment and this
case NPV become positive.
6. Government Policy: A government policy which shelters a firm from the onslaught of
competition enables it to earn superior returns. Government policies that create entry barriers,
partial or absolute, include the following:
Restrictive licensing
Import restrictions
High tariff walls
Environmental controls
Special tax reliefs
Government Policy can help a firm to create of positive Net Present Value.
Discuss the sources of positive Net Present Value (NPV).
BBA (Professional) 2008, 2010
2.07 STEPS INVOLVED IN MARKET AND DEMAND ANALYSIS

Necessary Steps:
1. Situation analysis and specification of objectives
2. Collection of secondary information
3. Conduct a market survey
4. Characterization of the market
5. Demand forecasting
6. Uncertainties of demand forecasting
7. Marketing plan
Step 1: Situation analysis and specification of objectives: In order to get a "feel" of the
relationship between the product and its market, the project analyst may informally talk to
customers, competitors, middleman and others in industry.
Step 2. Collection of Secondary information: In order to answer the questions listed while
delineating the objectives of the market study, information may be obtained from secondary
source and primary source.
Step 3. Conduct of market survey: For getting primary and secondary information market
survey is need to be done.
Step 4. Characterization of the market:
(i) Effective demand in the past and present;
(ii) Breakdown of demand;
(ii) Price;
(iii) Methods of distribution and sales promotion;
(v) Consumers;
(vi) Supply and competition;
(vii) Government policy.
Step 5. Demand forecasting: After gathering information about various aspects of the market
and demand from primary and secondary sources, an attempt may be made to estimate future
demand.
Step 6. Uncertainties in demand forecasting:
(i) Data about past and present market;
(ii) Methods of forecasting;
(iii) Environmental change.
Step 07. Market planning:
(i) Current marketing situation;
(ii) Opportunity and issue analysis
(iii) Objective
(vi) Marketing strategy;
(vii) Action programmed.
What are the steps involved in market and demand analysis?
Discuss the steps involved in market and demand analysis. BBA (Profe.) 2007
"Market and Demand Analysis involve consideration and implementation of certain
specific and sequential steps". Justify the statement using a diagram and also
mention the objectives of Market and Demand Analysis.
2.08 GENERAL SOURCES OF SECONDARY INFORMATION

Secondary information are those which are collected by some other agency and are used for
further investigation. The sources of secondary information can be classified into two:
(1) Published sources.
(2) Unpublished sources.
SECONDERY INFORMATION
Published Sources Unpublished Sources
Government Private Semi-official Commissions International

Publications Publications Publications Reports Publications
1. PUBLISHED SOURCES
Some of the published sources providing secondary information are:
Government Publications: A number of government, semi-government and private
organizations collect data related to business, trade, prices, consumption, production, industries,
income, health, population etc. These publications are very powerful source of secondary
information, Bangladesh Bureau of Statistics (B.B.S.), National Sample Survey (N.S.S.),
Directorate of Economics and Statistics and Labour Bureau, Ministry of labour are a few
government publications.
International Publications: Various governments in the world and international agencies
regularly publish reports on data collected by them on various aspects. For example. U.N.Os
Statistical Year Book, Demography Year book etc can be named in this category.
Semi-official Publications: Local bodies like District Boards, Municipal Corporations
publish periodical.; providing information about vital factors like health, births, deaths etc.
Reports of Committees and Commissions: At times governments service commission
and commissions with a specific reference to study a phenomenon. The reports of these
committees and commissions provide important secondary information. For example,
Education commission report on education reforms, Report of National Agricultural
Commission, Taxation and Pay commission reports etc.
Private Publications: The following private publications may also be enlisted as the
source of secondary information :
Journals and Newspapers: Eastern Economists, Monthly Statistics of Trade, Financial
Express, Economic Times are some of the Journals and Newspapers which regularly collect and
publish data on various aspects of business, economics, commerce and trade.
Research Publications: A number of research organizations, university departments and
institutes like Bangladesh Statistical Burrow (BSB), N.C.T.B., etc also contribute significantly
to the availability of secondary information.
Publications of Business and Financial Institutions: A number of business and
financial institution like chamber of commerce and Trade Association, Institute of Charted
Accountants, Sugar Mill Association, Stock Exchanges Trades Unions and co-operative
societies, etc. also contribute significantly for the availability of secondary data in the related
areas.
Articles: Market Reviews and reports also provide data for analysis.
2. UNPUBLISHED SOURCES
In some cases data are collected but these are not put in published from. For example research
scholars in the institutes and universities, trade associations and labour bureaus do collect data
but they never put it in published from. Still, the data from these sources may be used when
needed.
What are the general sources of Secondary information?
How would you evaluate secondary information? BBA (Professional) 2010
2.09 STEPS IN A SAMPLE SURVEY
Sample survey now a days, is the most efficient technique of providing relevant information for
drawing inference about a population. From economic point of view, it is the only viable means to
study the population. It is therefore essential to describe the main steps involved in executing a
sample survey. The following are some of the step:
1. Define the target population: In defining the target population the important terms should be
carefully and unambiguously defined.
2. Selecting the sampling scheme and sample size: There are several sampling schemes: simple
random sampling, cluster sampling, sequential sampling etc. from these a sampling scheme is to
be selected.
3. Develop the questionnaire: The questionnaire is the principal instrument for eliciting
information from the sample respondents.
4. Recruit and train the field investigators: Recruiting and training of field investigators must
be planned well since it can be time consuming.
5. Obtain information as per the questionnaire from the sample of respondents: Respondents
may be interviewed personally, telephonically or by mail for obtaining information personal
interview ensure a high rate of response.
6. Scrutinize the information gathered: Information gathered should be thoroughly scrutinized
to estimate date which is internally inconsistent and which is of dubious validity.
7. Analyze and interpret the information: Information gather in the survey needs to be
analyzed and interpreted with care and imagination.
Discuss the key steps in a sample survey. BBA (Professional) 2009,2010,2011,2013
2.10 CHARACTERISTICS OF THE MARKET

A market system is any systematic process enabling many market players to bid and ask: helping
bidders and sellers interact and make deals. It is not just the price mechanism but the entire
system of regulation, qualification, credentials, reputations and clearing that surrounds that
mechanism and makes it operate in a social context. We will characterize the market in the
following way.
1. Effective demand in the past and present: To gauge the effective demand in the past and
present, the starting point typically is apparent consumption which is defined as:
Production + Imports - Exports - Changes in stock level
2. Break down of demand: To get a deeper insight into the nature of demand, the aggregate
market demand may be broken down into demand for different segments of the market. Market
segments may be defined by - (i) Nature of product; (ii) Consumer group; (iii) Geographical
division.
3. Price: Price statistics must be gathered along with statistics pertaining to physical quantities./
4. Methods of distribution and sales promotion: The method of distribution may very with the
nature of the product. Capital goods, industrial raw materials or intermediates and consumers
products tend to have different distribution channels.
5. Consumers: Consumers may be characterized along two dimensions as follows: (i)
Demographic and Sociological; (ii) Attitudinal
6. Supply and competition: It is necessary to know the existing sources of supply and whether
they are foreign or domestic.
7. Government policy: The role of the government in influencing the demand and market for a
product may be significant.
How would you characterize the market? BBA (Professional) 2014
2.11 DEMAND FORECASTING

Demand Forecasting refers to the prediction of the probable demand for a good 01 a service on
the basis of the past events and the prevailing trends In the present. In other words, it tells the
expected level of demand at some future date by considering the past and present behaviour
pattern of the related events. Thus, Demand Forecasting means when, how, where and how
much will be the demand for a product or service in the near future. Since 'Demand Forecasting'
is also known as 'Sales Forecasting', therefore some writers have defined it Sales Forecasting.
According to Cundiff and Still, "Demand Forecasting is an estimate of Demand during a
specified period. Which estimate is tied to a proposed marketing plan and which assumes a
particular set of uncontrollable and competitive forces."
In the words of Prof. Philip Kotler, "The company (sales) forecast is the expected level of
company sales based on a chosen marketing plan and assumed marketing environment."
According to Evan J. Douglas, "Demand forecasting may be defined as the process of finding
values for demand in future time periods."
According to American Marketing Association, Demand Forecasting is an estimate of sales
in dollars or physical units for a specified future period under a proposed marketing plan.
Thus, the process of Forecasting Demand or sales may, therefore, be broken into two parts,
namely, an analysis of the past conditions and analysis of current conditions with reference to a
probable future tendency.
What do you mean by demand forecasting? BBA (Professional) 2009
Define demand forecasting.
2.12 DEMAND FORECASTING METHODS

1. Qualitative methods: These methods rely essentially on the judgment of experts to translate
qualitative information into quantitative estimates. The important qualitative methods are:
a. Jury of executive method: This method, which is very popular in practice, involves soliciting
the opinions of a group of managers on expected future sales and combining them into a sales
estimate.
b. Delphi method: This method is used for eliciting the opinions of experts with the help of a
mail survey.
2. Time series projection methods: This method generates forecast on the basis of an analysis of
the historical time series. The important time series projection methods are:
a. Trend projection method: The trend projection methods involves - determining the trend of
consumption by analyzing past consumption statistics and projecting future consumption by
extrapolating the trend,
b. Exponential smoothing method: In exponential smoothing forecasts are modified in the light
of observed errors,
c. Moving average methods: As per the moving average methods of sales forecasting, the
forecast for the next period is equal to the average of the sales for several preceding periods.
3. Causal method: More analytical than the proceeding methods, causal methods seek to develop
forecasts on the basis of cause-effect relationship specified in an explicit, quantitative manner.
The important causal methods are:- Chain ratio method;/ Consumption level method;/ End use
method; /Leading indicator method;/ Economic methods. Describe briefly the methods available
for demand forecasting. (2009)
Describe briefly the methods available for demand forecasting.
BBA (Professional) 2009,2011
2.13 MEANS OF FINANCING

To meet the cost of project the following means of finance are available:
1. Share capital
2. Term loans
3. Debenture capital
4. Deferred credit
5. Incentive sources
6. Miscellaneous sources
1. Share capital: There are two types of share capital-equity capital and preference capital.
Equity capital represents the contribution made by the owners of the business, the equity
shareholders, who enjoy the rewards and bear risks of ownership. Equity capital being the risk
capital carries no fixed rate of dividend. Preference capital represents the contribution made by
preference shareholders and the dividend paid on it is generally fixed.
2. Term Loans: Term loans are provided by financial institutions and commercial banks
represents secured borrowings which are a very important source for financing new projects as
well as expansion, modernization, and renovation schemes of existing firms. There are two broad
types of term loans available in India: rupee term loans and foreign currency term loans. While
the former are given for financing land, building, civil works, indigenous plant and machinery,
and so on, the latter are provided for meeting the foreign currency expenditures towards the
import of equipment and technical know how.
3. Debenture capital: Debentures are instruments for raising debt capital. There are two broad
types of debentures: convertible debentures and non convertible debentures. Convertible
debentures as the name implies, are debentures which are convertible, wholly or partly, in to
equity shares. The conversion period and price are announces in advance.
4. Deferred credit: Many a time the suppliers of plant and machinery offer a deferred credit
facility under which payment for the purchase of plant and machinery can be made over a period
of time.
5. Incentive sources: The government and its agencies may provide financial support as
inventive to certain types of promoters or for setting up industrial units in certain locations. These
incentives may be in the form of seed capital assistance, capital subsidy or tax exemption for a
certain period.
6. Miscellaneous sources: A small portion of project finance may come from miscellaneous
sources like unsecured loans, public deposits, and leasing and hire purchase finance. Unsecured
loans are typically provided by the promoters to bridge the gap between the promoters
contribution and the equity capital the promoters can subscribe to. Public deposits represent
unsecured borrowings from the public at large. Leasing and hire purchase finance represent a
form of borrowing different form the conventional term loans and debenture capital.
Describe briefly the various means of financing of a project.
BBA (Professional) 2007, 2009,2010,2011
2.14 KEY BUSINESS CONSIDERATIONS

The key business considerations which are relevant for the project financing decision are: cost,
risk, control, and flexibility. These are explained in brief.
1. Cost: In general the cost of debt funds is lower than the cost of equity funds. Why? The
primary reason is that the interest payable on debt capital is a tax-deductible expense whereas the
dividend payable on equity capital is not.
2. Risk: The two main sources of risk for a firm (or project) are: business risk and financial risk.
Business risk refers to the variability of return on invested capital and arises mainly from
fluctuations in demand and variability of prices and costs. Financial risk represents the risk
arising from financial leverage. It must be emphasized that while debt capital is a cheaper source
of finance it is also a riskier source of finance because of the fixed financial burden associated
with it.
3. Control: From the point of view of the promoters of the project, the issue of control is
important. They would ordinarily prefer a scheme of financing which enables them to maximize
their control, current as well as potential, over the affairs of the firm, given their commitment of
funds to the project.
4. Flexibility: This refers to the ability of a firm (or project) to raise further capital from any
source it wishes to tap to meet the future financing needs. This provides maneuverability to the
firm. In most practical situations, flexibility means that the firm does not fully exhaust its debt
capacity.
Discuss the key business considerations relevant for project financing decision.
2.15 MEASUREMENT OF PRICE ELASTICITY OF DEMAND

There are five methods of measuring price elasticity of demand :
(1) Total Outlay or Total Expenditure Method
(2) Proportionate or percentage Method
(3) Point Elasticity Method
(4) Arc Elasticity Method Graphic Method
(5) Revenue Method
(1) Total Outlay or Expenditure Method: Total expenditure or outlay method of measuring
elasticity of demand was evolved by Dr. Marshall. According to this method, in order to measure
the elasticity of demand it is essential to know how much and in what direction the total
expenditure has changed as a result of change in the price of a good.
Measurement of elasticity of demand by total outlay (expenditure) method is explained with the
help of the following table.
Price Changes, Elasticity and Total Expenditure
How Total expenditure Changes
Price Elasticity of Demand Price Increases Price Decreases
Inelastic or Less Than Unitary Ed < 1 Total Expenditure Increases Total Expenditure Decreases
Unitary Elastic Ed = 1 No change in Total Expenditure No change in Total Expenditure
Elastic or Greater than Unitary Ed >1 Total Expenditure Decreases Total Expenditure Increases
(2) Proportionate or percentage Method: The second method of measuring price elasticity of
demand is called proportionate or percentage method. According to this method, percentage
change in demand is divided by percentage change in price. Its formula is as under:
(3) Point Elasticity of Demand or Point Elasticity Method: Point elasticity refers to price
elasticity of demand at any point on the demand curve. In other words, this method is used to
know the elasticity of demand of different points on a linear demand curve.
According to Left witch, "Elasticity computed at a single
point on the curve for an infinitely small change in price, is
point elasticity."
Price elasticity on a linear demand curve depends on the
slope of the curve and the point at which the measurement is
PRICE (Tk.)
made. Thus, price elasticity of demand is different at
different points on a given demand curve. Accordingly, price
elasticity at every point of a given demand curve is measured
separately. Under this method the price elasticity of demand
is calculated by the following formula.
(4) Arc Elasticity: Arc Elasticity is a measure of the average

responsiveness to price change shown by the demand curve
over some definite portion between two points on a demand
curve. An arc is the portion between two points on a demand PRICE (Tk.)
curve. The portion between two points A and C on the demand
curve DD as shown in Fig. 12 is called Arc. The elasticity
obtained when mid-point or average price and quantity are
used is called the Arc Elasticity.
According to Watson, "Arc elasticity is the elasticity at the mid-point of an arc of a demand
curve."
In the words of Ferguson, "Arc elasticity is a measure of the average elasticity between two
points on the demand curve."
One complication is inherent in this concept. In the elasticity formula:
(5) Revenue Method: Fifth method of calculating price elasticity of demand is called revenue
method. Sale proceeds that a firm obtains by selling its products is called its revenue. Price
elasticity of demand is measured with the help of average and marginal revenue as per the
following formula-
How is price elasticity of demand measured? BBA (Professional) 2010
2.16 MEASUREMENT OF INCOME ELASTICITY OF DEMAND

Income elasticity of demand meatus the ratio of the percentage change in the quantity demanded
to the percentage change in income.
Income elasticity can be measured by the following formula:
How is income elasticity of demand measured? BBA (Professional) 2010
2.17 CONSIDERATION WHILE ESTIMATING SALES REVENUE

In estimating sales revenues, the following considerations should be borne in mind:
1. It is not advisable to assume a high capacity utilization level in the first year of operation. Even
if the technology is simple and the company may not face technical problems in achieving a high
rate of capacity utilization in the first year itself, there are likely to be other constraints like raw
material shortage, limited power, marketing problems, etc. It is sensible to assume that capacity
utilization would be somewhat low in the first year and rise thereafter gradually to reach the
maximum level in the third or fourth year of operation. A reasonable assumption with respect to
capacity utilization is as follows: 40-50 per cent of the installed capacity in the first year, 50-80
per cent in the second year, and 80-90 per cent from the third year onwards.
2. It is not necessary to make adjustments for stocks of finished goods. For practical purposes, it
may be assumed that production would be equal to sales.
3. The selling price considered should be the price realisable by the company net of excise duly.
11 shall, however, include dealers' commission which is shown as an item of expense (as part of
the sales expenses).
4. The selling price used may be the present selling price -it is generally assumed that changes in
selling price will be matched by proportionate changes in cost of production. 1 If a portion of
production is saleable at a controlled price, take the controlled price for that portion.
What consideration should be kept in mind while estimating sales revenue?
2.18 PROJECTS, PROGRAMMED TASKS AND ACTIVITY PACKAGES

Capital budgeting is a complex process and there are five broad phases. These are planning,
analysis, selection, implementation and overview.
Planning
Analysis
Selection
Implementation
Review
1. Planning: The planning phase involves investment strategy and the generation and preliminary
screening of project proposals. The investment strategy provides the framework that shapes,
guides and circumscribes the identification of individual project opportunities.
2. Analysis: If the preliminary screening suggests that the project is worth investing, a detailed
analysis of the marketing, technical, financial, economic, and ecological aspects is conducted.
3. Selection: The selection process addresses the questionis the project worth investing? A
wide range of appraisal criteria has been suggested to judge the worth of a project. There are two
broad categories. They are Non-Discounting criteria and Discounting criteria. Some selection
rules for both methods are listed below: -
Non-discounting criteria Accept Reject
Pay Back Period (PBP) PBP < target period PBP >target period
Accounting Rate of Return (ARR) ARR > target rate ARR < target rate
Discounting criteria Accept Reject
Net Present Value (NPV) NPV > 0 NPV < 0
Internal Rate of Return (IRR) IRR > cost of capital IRR < cost of capital
Benefit- Cost Ratio (BCR) BCR >1 BCR < 1
4. Implementation: The implementation phase for an industrial project, which involves the
setting up of manufacturing facilities, consists of several stages:
Project and engineering designs
Negotiations and contracting
Construction
Training
Plant commissioning
5. Review: Once the project is commissioned, a review phase has to be set in motion.
Performance review should be done periodically to compare the actual performance with the
projected performance. In this stage, feedback is useful in several ways:
It focuses on realistic assumptions
It provides experience, which will be valuable in future decision making
It suggests corrective action
It helps to uncover judgmental biases
It advocates the need for caution among project sponsors.
Levels of decision making: In addition to various phases of capital budgeting, it is important to
look at different levels of decision-making. These are operating, administrative and strategic
decision making levels
Decision Applications (for example) Decided by
Routine maintenance and
Operating decisions Lower-level mgmt.
minor office equipment
Yearly maintenance and
Administrative decisions Middle-level mgmt
Balancing equipment
Strategic decisions Expansions, diversifications Top-level mgmt/Board
Describe the phases of capital budgeting?
2.19 NET PRESENT VALUE (NPV)

Definition: Net present value method is one of the modern methods for evaluating the project
proposals. In this method cash inflows are considered with the time value of the money. Net
present value describes as the summation of the present value of cash inflow and present value of
cash outflow. Net present value is the difference between the total present value of future cash
inflows and the total present value of future cash outflows.
Formula:
NPV =
Where,
CFt = Cash flow in + periods or NCB
k = The cost of capital
CF0 = Cash flow in O period or Initial Investment
Advantages:
1. It recognizes the time value of money.
2. It considers the total benefits arising out of the proposal.
3. It is the best method for the selection of mutually exclusive projects.
4. It helps to achieve the maximization of shareholders wealth.
Limitations
1. It is difficult to understand and calculate.
2. It needs the discount factors for calculation of present values.
3. It is not suitable for the projects having different effective lives.
Accept/Reject criteria:
If the present value of cash inflows is more than the present value of cash outflows, it would be
accepted. If not, it would be rejected.
Define NPV. What are the limitations of NPV? BBA (Professional) 2011
2.20 MIRR IS BETTER

Regular IRR have significant drawbacks. Care should be exercised in interpreting what the
measures are implying. The drawbacks include:-
(a) Management is locked into assumptions about how free cash flows will be reinvested,
thereby giving an unrealistic view of an investments real potential;
(b) Problems of size, timing, and ranking make comparisons among alternatives difficult
when budgets are limited or projects are mutually exclusive; and
(c) Regular IRR suffers from the special problem of multiple IRRs.
MIRR deals with these problems by specifically recognizing that cash flows produced by an
investment can be reinvested. MIRR is a more accurate measure of the attractiveness of an
investment alternative because attractiveness depends not only on the return on the investment
itself, but also on the return expected from cash flows it generates. Executives seeking to hone
their decision making skills will do well to consider the power of this measure.
Why MIRR is better than regular IRR? BBA (Professional) 2013
2.21 ADDITIVE PROPERTY OF NPV

ADDITIVE PROPERTY OF NET PRESENT VALUES
The net present value of a package of projects is simply the sum of the net present values of
individual projects included in the package.
IMPLICATIONS OF THE ADDITIVE PROPERTY OF NPV

This property has several implications:
1. The value of a firm can be expressed as the sum of the present value of projects in place as well
as the net present value of prospective projects :
Value of a firm = +
The first term on the right hand side of this equation captures the value of assets in place and the
second term the value of growth opportunities.
2. When a firm terminates an existing project which has a negative NPV based on its expected
future cash flows, the value of the firm increases by that amount. Likewise, when a firm
undertakes a new project that has a negative NPV, the value of the firm decreases by that amount.
3. When a firm divests itself of an existing project, the price at which the project is divested
affects the value of the firm. If the price is greater/lesser than the present value of the anticipated
cash flows of the project the value of the firm will increase/ decrease with the divestiture.
4. When a firm makes an acquisition and pays a price in excess of the present value of the
expected cash flows from the acquisition it is like taking on a negative NPV project and hence
will diminish the value of the firm.
5. When a firm takes on a new project with a positive NPV, its effect on the value of the firm
depends on whether its NPV is in line with expectation.
What are the implications of the additive property of npv? BBA (Profe.) 2013
2.22 FACTORS INFLUENCING THE CHOICE OF TECHNOLOGY

The choice of technology is influenced by a variety of factors considerations:
Plant capacity
Principal inputs
Investment outlay and production cost
Use by other units
Product mix
Latest developments
Ease of absorption
(i) Plant Capacity: Often, there is a close relationship between plant capacity and production
technology- To meet a given capacity requirement perhaps only a certain production technology
may be viable.
(ii) Principal inputs: The choice of technology depends on the principal inputs available for the
project. In some cases, the raw materials available influences the technology chosen.
(iii) Investment outlay and production cost: The effect of alternative technologies of
investment outlay and production cost over a period of time should be carefully assessed.
(iv) Use by other units: The technology adopted must be proven by successful use by other
units, preferably in Bangladesh.
(v) Product mix: The technology chosen must be judged in terms of the total product-mix
generated by it, including saleable byproducts.
(vi) Latest developments:The technology adopted must be based on latest development in order
to ensure that the likelihood of technological obsolescence in the near future, at least, is
minimized.
(vii) Ease of absorption: The ease with which a particular technology can be absorbed can
influence the choice of technology. Sometimes a high-level technology may be beyond the
absorptive capacity of a developing country which may lack trained personnel to handle that
technology.
Discuss the factors influencing the choice of technology. BBA (Professional) 2007
Name the factors that have a bearing on choice of technology. BBA (Profe.) 2009
What factors have a bearing on the choice of technology?
2.23 TECHNICAL AND ENVIRONMENTAL ANALYSIS

TECHNICAL ANALYSIS
The technical analysis of a project idea includes designing the various processes, installing
equipment, specifying material, and prototype testing. The project manager has to be careful in
finalizing the technical aspects of the project as the decision is irreversible and the investments
involved may be high. The project manager has to select the technology required in consultation
with technical experts and consultants.
ENVIRONMENTAL ANALYSIS
In the modern world, because of the rapid development of industry, pollution has reached
alarming proportions. There are various factors like government regulations and pressure from
consumers, local people and investors, which force the firm to act in a more environment-friendly
manner. Therefore, location of the project, type of technology to be used, and method of effluent
disposal are decided only after taking these factors into consideration.
Define technical analysis. BBA (Professional) 2012
2.24 COST OF PROJECT

DEFINITION
A project is concerned finance is the basic prerequisite. Without proper financial arrangement an
entrepreneur is finding difficult to go ahead with his project. Funds requirement should be
optimum so as to avoid the problems of both under and over capitalization. So the cost project
should be accurately estimated. Once the estimation of cost of project is over, the next step is to
find out the sources of financing. After identifying the various available sources, a finance mix
should be finalized. The selected finance mix should be optimum from the point of view of cost,
control and flexibility.
The cost of project represents the total of all items of outlay associated with a project which are
supported by long-term funds.
COMPONENTS OF COST OF PROJECT
The major components or elements of cost of project are the following:
1. Land and site development
2. Buildings and civil works
3. Plant and 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 and capital issue expenses
8. Pre-operative expenses
9. Initial cash losses
10. Margin money for working capital
11. Provision for contingencies

1. Land and site development: This includes basic cost of land, premium payable on lease hold,
cost of leveling and development, cost of laying approach roads, cost of gates, cost of tube wells
etc. The cost of land varies considerably from one location to another location. Similarly the
expenditure on site development also varies according to topography of the land.
2. Buildings and civil works: This includes buildings for the main plant and equipment, building
for auxiliary services like workshops, laboratory etc., godowns, warehouses, quarters for staff
etc. The cost of buildings and civil works depends on the kinds of structures required. Once the
kinds of structures required are specified, cost estimates are based on the plinth area and rates for
various types of structures.
3. Plant and machinery: The cost of plant and machinery is the most significant component of
the project cost. This includes the cost of imported machinery and its allied cost, cost of
indigenous machinery, cost of stores and spares and installation and foundation charges. The cost
of the plant and machinery is based on the latest available quotation adjusted for possible
escalation.
4. Technical know-how and Engineering fees: Often it is necessary to engage technical

consultants or collaborators from India and/or abroad for advice and help in various technical
matters like preparation of the project report, choice of technology, selection of the plant and
machinery, and so on. So the amount payable for obtaining the technical know-how and
engineering services for setting up the project is an important component of the project cost.
5. Expenses on foreign technicians and training of Indian technicians abroad: Services of
foreign technicians may be required in India for setting up the project and supervising the trial
runs. Expenses on their travel, boarding, and lodging along with their salaries and allowances
must be shown here. Likewise, expenses on Indian technicians who require training abroad must
also be included here.
6. Miscellaneous fixed assets: Fixed assets which are not part of the direct manufacturing
process may be referred to as miscellaneous fixed assets. They include items like furniture, office
machinery and equipment, tools, vehicles, railway sidings, diesel generating sets, transformers,
boilers, piping systems, laboratory equipment etc. Expenses incurred for the procurement or use
of patents, licenses, trademarks, copyrights, etc. and deposits made with electricity board may
also be included here.
7. Preliminary and capital issue expenses: Expenses incurred for identifying the project,
conducting market survey, preparing feasibility report, drafting memorandum and articles of
association and incorporating the company are referred to as preliminary expenses. Expenses
borne in connection with the raising of capital from the public are referred to as capital issue
expenses. The major components of capital issue expenses are: underwriting commission,
brokerage, fees to managers and registrars, printing and postage expenses, advertising and
publicity expenses, listing fees, and stamp duty.
8. Pre-operative expenses: Some revenue expenses incurred till the commencement of
commercial production are referred to as pre-operative expenses. This includes establishment
expenses, rent, rates and taxes, travelling expenses, interest and commitment charges on
borrowings, insurance charges, mortgage expenses, interest on deferred payments, start-up
expenses, and miscellaneous expenses.
9. Provision for contingencies: A provision for contingencies is made to provide for certain
unforeseen expenses and price increases over and above the normal inflation rate which is already
incorporated in the cost estimates.
10. Margin money for working capital: The principal support for working capital is provided
by commercial banks and trade creditors. However, a certain part of the working capital
requirement has to come from long-term sources of finance. Referred to as the margin money
for working capital, this is an important element of the project cost.
11. Initial cash losses: Most of the projects incur cash losses in the initial years. Yet, promoters
typically do not disclose the initial cash losses because they want the project to appear attractive
to the financial institutions and investing public. Failure to make a provision for such cash losses
in the project cost generally affects the liquidity position and impairs the operations.
Define cost of a project? What are the components/factors of cost of a project?

2.25 PROPERTIES OF THE NPV RULE

The net present value has certain properties that make it a very attractive decision criterion. These
properties are stated below.
1. The value of a firm can be expressed as the sum of the present value of projects in place as well
as the net present value of prospective projects:
Value of a firm = +
2. When a firm terminates an existing project which has a negative NPV based on its expected
future cash flows, the value of the firm increases by that amount. Likewise, when a firm
undertakes a new project that has a negative NPV, the value of the firm decreases by that amount.
3. When a firm divests itself of an existing project, the price at which the project is divested
affects the value of the firm. If the price is greater/lesser than the present value of the anticipated
cash flows of the project the value of the firm will increase/ decrease with the divestiture.
4. When a firm takes on a new project with a positive NPV, its effect on the value of the firm
depends on whether its NPV is in line with expectation.
5. When a firm makes an acquisition and pays a price in excess of the present value of the
expected cash flows from the acquisition it is like taking on a negative.
Explain the properties of NPV. BBA (Professional) 2007, 2012
2.26 PROBLEMS WITH IRR

There are several problems with the IRR. These are explained below.
1. IRR is sometime misapplied, under an assumption that interim positive cash flows are
reinvested at the same rate of return as that of the project that generated them. This is usually an
unrealistic scenario and a more likely situation is that the funds will be reinvested at a rate closer
to the firm's cost of capital. The IRR therefore often gives an unduly optimistic picture of the
projects under study. Generally for comparing projects more fairly, the weighted average cost of
capital should be used for reinvesting the interim cash flows.
2. More than one IRR can be found for projects with alternating positive and negative cash flows,
which leads to confusion and ambiguity. MIRR finds only one value.
3. Another remarkable problem of IRR method is that IRR, as an investment decision tool, should
not be used to rate mutually exclusive projects, but only to decide whether a single project is
worth investing in.
4. IRR overstates the annual equivalent rate of return for a project whose interim cash flows are
reinvested at a rate lower than the calculated IRR.
6. IRR does not consider cost of capital; it should not be used to compare projects of different
duration.
7. In the case of positive cash flows followed by negative ones and then by positive ones, the IRR
may have multiple values.
Discuss the problems associated with IRR. BBA (Professional) 2007, 2012
2.27 DIFFERENT PHASES OF CAPITAL BUDGETING

Capital budgeting is the process of determining whether a big expenditure is in a company's best
interest. Here are the different phases of capital budgeting:
1. Capital Budgeting Basics: A company undertakes capital budgeting in order to make the
best decisions about utilizing its limited capital. For example, if you are considering opening
a distribution center or investing in the development of a new product, capital budgeting will
be essential. It will help you decide if the proposed project or investment is actually worth it
in the long run.
2. Identify Potential Opportunities: The first step in the capital budgeting process is to
identify the opportunities that you have. Many times, there is more than one available path
that your company could take. You have to identify which projects you want to investigate
further and which ones do not make any sense for your company. If you overlook a viable
option, it could end up costing you quite a bit of money in the long term.
3. Evaluate Opportunities: Once you have identified the reasonable opportunities, you need to
determine which ones are the best. Look at them in relation to your overall business strategy
and mission. See which opportunities are actually realistic at the present time and which ones
should be put off for later.
4. Cash Flow: Next, you need to determine how much cash flow it would take to implement a
given project. You also need to estimate how much cash would be brought in by such a
project. This process is truly one of estimating--it takes a bit of guesswork. You need to try to
be as realistic as you can in this process. Do not use the best-case scenario for your numbers.
Most of the time, you need to use a fraction of that number to be realistic. If the project takes
off and the best-case scenario is reached, that is great. However, the odds of that happening
are not the best on new projects.
5. Select Projects: After you look at all of the possible projects, it is time to choose the right
project mix for your company. Evaluate all of the different projects separately on their own
merits. You need to come up with the right combination of projects that will work for your
company immediately. Choose only the projects that mesh with your company goals.
6. Implementation: Once the decisions have been made, it is time to implement the projects.
Implementation is not really a budgeting issue, but you will have to oversee everything to be
sure it is done correctly. After the project gets started, you will need to review everything to
make sure the finances still make sense.
Illustrate different phases of capital budgeting BBA (Professional) 2014
2.28 SOCIAL COST BENEFIT ANALYSIS

Social cost-benefit analysis is a systematic and cohesive economic tool(method) to survey all the
impacts caused by an urban development project. It comprises not just the financial effects
(investment costs, direct benefits like tax and fees, et cetera), but all the social effects, like:
pollution, safety, indirect (labour) market, legal aspects, et cetera. The main aim of a social cost-
benefit analysis is to attach a price to as many effects as possible in order to uniformly weigh the
above-mentioned heterogeneous effects. As a result, these prices reflect the value a society
attaches to the caused effects, enabling the decision maker to form a statement about the net
social welfare effects of a project.
Social Cost Benefit Analysis (SCBA) is also referred as Economic Analysis (EA). SCBA or EA is
a feasibility study of a project from the viewpoint of a society to evaluate whether a proposed
project will add benefit or cost to the society. That is, it is an approach that is concerned to judge
the economic and social viability of a project especially public expenditure project or donor-
led programs.
What is social cost benefit analysis? BBA (Professional) 2008, 2012
2.29 RATIONALE FOR SCBA

In SCBA the focus is on the principal sources of discrepancy between social costs and benefits on
the one hand and monetary cost and benefits on the other. These often tend to differ from the
monetary costs and benefits of the project. The principal sources of discrepancy are:
1. Market Imperfection
2. Taxes and Subsidies
3. Concern for Savings
4. Concern for redistribution
5. Merit Wants
1. Market Imperfections: Market prices, which form the basis for computing the monetary costs
and benefits from the point of view of the project sponsor reflect social values only countries.
When imperfections exist, market prices do not reflect social values. The common market
imperfections found in developing countries are:
(i) Rationing,
(ii) Prescription of minimum wage rates, and
(iii) Foreign exchange regulation.
2. Taxes Subsidies: From the private point of view, taxes are definite monetary costs and
subsidies are definite monetary gains. From the social point of view, however, taxes and subsidies
are generally regarded as transfer payments and hence considered is relevant.
3. Concern for Savings: Unconcerned about how its benefits are divided between consumption
and savings, a private firm does not put differential valuation on savings and consumption and
savings (which leads to investment) is relevant, particularly in the capital-scarce developing
countries.
4. Concern for Redistribution: A private firm does not bother how its benefits are distributed
across various groups in the society. The society, however, is concerned about the distribution of
benefits across different groups.
5. Merit Wants: Goals and preferences not expressed in the market place, but believed by
policymakers to be in the larger interest, may be referred to as merit wants.
Explain the principal sources of discrepancy for social cost benefit analysis. Or,
Discuss the principal sources of discrepancy between social costs and benefits on
the one hand and monetary cost and benefits on the other.
BBA (Professional) 2007, 2012, 2014
2.30 UNIDO APPROACH OF PROJECT APPRAISAL

The UNIDO Approach for Social Cost Benefit Analysis as prescribed by United Nation Industrial
Development Organization (UNIDO) was applied to a thermal coal based power plant and a
hydro plant.
UNIDO approach is one of the methods of calculating Social cost benefit analysis (SCBA) in fact
very popular. Normally we calculate financial benefits from a project while evaluating it, but this
method calculates economic benefits from the project. Although earlier it was commonly used by
government organizations but now it is being used by private players also. In this analysis the
monetary priced are replaced by shadow prices. Shadow prices are prices at perfect market
conditions, also called as economic prices.
Illustrate UNIDO approach . BBA (Professional) 2007, 2012
2.31 STAGES OF UNIDO APPROACH

UNIDO approach is one of the methods of calculating Social cost benefit analysis (SCBA) in fact
very popular. UNIDO Approach is a five stage methodology:
1. Calculation of financial profitability measured at market prices.
2. Obtaining the net benefit of the project measured in terms of economic prices.
3. Adjustment for the impact of the project on savings and investment.
4. Adjustment for the impact of the project on income distribution.
5. Adjustment for the impact of the project on merit goods and demerit goods
Briefly explain the stages of UNIDO approach in project appraisal.
2.32 UNIDO VS LM APPROACH

SIMILARITIES
1. The calculation of shadow price particularly for foreign exchange saving and unskilled labor is
same in both methods.
2. Both methods consider factors of equity.
3. Both methods use DCF (Discounted Cash Flow) methods.
DISSIMILARITIES
1. UNIDO method also emphasis calculation of financial profitability of market prices along
with SCBA but this is not so done in case of Little-Mirrlees method.
2. Little-Mirrlees method measures cost and benefit in terms of international currency that is in
border price or world price in $. UNIDO approach measure costs and benefits in terms of
domestic currency.
3. In case of Little-Mirrlees approach measures cost and benefit in terms of uncommitted social
income. On the other hand in UNIDO method it measures the same in terms of domestic
consumption.
4. UNIDO approach focuses efficiency, saving and redistribution of income stage by stage while
Little-Mirrlees approach considers the same in totality.
Briefly explain the similarities and dissimilarities UNIDO between LM approach .
BBA (Professional) 2007,2009, 2011, 2013, 2014
2.33 SHADOW PRICING

The terms "Shadow Price" or "Shadow Pricing" are used to refer to monetary values assigned to
currently unknowable or difficult to calculate costs. Shadow pricing has two definitions, which
are as follows:
1. The assignment of a price to an intangible item for which there is no ready market from which
to derive a price. Shadow prices are most commonly used in cost-benefit analyses where some
elements of the analyses cannot be quantified by reference to a market price or a cost.
2. The maximum price that a business should be willing to pay for one additional unit of some
type of resource. This definition relates to the perceived benefit that management believes it can
obtain from the additional unit. An example of this definition is the cost of paying overtime to
employees to stay on the job and operate a production line for one more hour. Thus, if the result
of keeping the production line running longer (the shadow price) exceeds the cost required to run
the line, management should do so.
What is shadow pricing? BBA (Professional) 2008
2.34 BASIC ISSUES OF SHADOW PRICING

The basic issues/concepts related to shadow pricing are as follows:
1. The unit of account in which the value of inputs/outputs (resources) is measured is the net
present consumption in the hands of people at the base level of consumption in the private sector,
in terms of constant price in domestic accounting currency (rupees).
2. For a tradable good, it is possible to substitute import/export for domestic
production/consumption and vice versa. The international/border price represents the real value
of the goods in terms of economic efficiency/shadow pricing of tradable goods.
3. Depending on the impact of the project on the national economy, there are three sources of
shadow pricing, that is, increase/decrease in (i) total consumption, (ii) production and (iii)
imports/exports as a project uses/produces resources for any given input/output. If the impact of
the project is on consumption in the economy, the basis of shadow pricing is on consumer
willingness to pay; if the impact is on production, the basis is cost of production and if the impact
is on exports/imports, the basis is foreign exchange value.
4. When a project results in (i) diversion of non-traded inputs that arc in fixed supply from the
producers or (ii) addition to non-traded consumer goods, taxes should be included, but it should
be excluded if it augments domestic production by other producers. Taxes should be ignored for
fully traded goods.
What are the basic issues/concepts related to shadow pricing ?
2.35 EXTERNALITIES
DEFINITION
Externalities are the costs and benefits that accrue to groups not targeted as beneficiaries of the
project. They are not deliberated created by the project sponsor but are an incidental outcome of
legitimate economic activity. They are beyond the control of the persons who are affected by it.
CHARACTERISTICS
Externalities may affect the country's objective either positively or negatively. The characteristics
of externalities can be summarized as under:
They are not created by the project sponsor deliberately, but they are the incidental outcomes of
the project.
Their effect may be either beneficial or harmful to the society.
Irrespective of whether beneficial or harmful, the externalities are beyond the control of those
who are benefited/affected by them.
They are sometimes difficult to identify and almost always difficult to measure.
EXAMPLES
Let us consider some examples.
1. A multi-purpose river valley project may result in preventing flooding of areas This benefit is
incidental to the project.
2. The approach roads made by a company may improve the transport system of an area
3. Training of employees may enhance their skills.
4. A school set up by a company max periodic education for the children of the locals.
5. A river valley project results in the submergence of farmlands.
6. A new airport in the vicinity causes noise pollution.
7. A river valley project may cause formation of mosquito breeding grounds
EFFECTS IN EVELUTION OF A PROJECT
We may use the following as measures of benefits or costs:
1 The value of flood prevention may be gauged in terms of the money saved by the government
that was earlier spent on flood relief every year.
2. The improvement of the transport system may result in saving of travelling time which can be
valued according to the hourly wages of the beneficiaries.
3. The benefit of training may be measured in terms of the increased wages that the trained
employee may get in alternative employment because of his improved skills.
4. The measure of the educational benefit to children may be measured in terms of their increased
earning capability.
5. The submergence of farmland may be measured in terms of the yield lost per annum
6. The fall in rental value of buildings in the vicinity of the airport because of the noise caused by
the airport may be used as a measure for the cost of noise pollution.
7. The value of the increase in the inflow of anti-malarial drugs into the area may be a measure of
the cost of the mosquito breeding grounds caused by the river valley project.
As we observe, the external effects are intangible in nature and hence it is very difficult to value
their costs/benefits. They are valued by using indirect means wherever possible. In situations
where the effects of externalities cannot be measured in monetary terms, at least some form of
qualitative evaluation should be done and incorporated in the project analysis.
Explain how externalities can effect a project? BBA (Professional) 2012
2.36 WILLINGNESS TO PAY (WTP)

Willingness to pay (WTP) is the maximum amount an individual is willing to sacrifice to
procure a good or avoid something undesirable. The price of any goods transaction will thus be
any point between a buyer's willingness to pay and a seller's willingness to accept.
If the impact of the project is on consumption in the economy, the basis of shadow price is the
consumer's willingness to pay. This can best be explained with the help of following figure.
Consumers willingness to pay

SS' represents the supply schedule and DD' represents the demand schedule. E represents the
equilibrium point. OQ the quantity bought and OP the price per unit. In conditions of perfect
competition, the person who buys the first unit is willing to pay OD. While the person who buys
the last unit is willing to pay OP The consumer's willingness to pay for various units is given by
the schedule DE. The total amount that the consumers are willing to pay for the product is
indicated by ODEQ. The actual amount paid by them is OPEQ. The difference between ODEQ
and OPEQ namely DEP. is called the consumer surplus. The concept of consumer's willingness to
pay is important for computing shadow prices.
Explain consumers willingness to pay? BBA (Professional) 2009,2012
2.37 QUANTITATIVE FORECASTING TECHNIQUES

Qualitative methods which are widely used in demand forecasting are stated below.
1. Regression Analysis: statically relates sales to one or more explanatory (independent)
variables. Explanatory variables may be marketing decisions (price changes, for instance),
competitive information, economic data, or any other variable related to sales.
2. Exponential smoothing: Exponential smoothing makes an exponentially smoothed weighted
average of past sales, trends, and seasonality to derive a forecast.
3. Moving average: Moving average takes an average of a specified number of past observations
to make a forecast. As new observations become available, they are used in the forecast and the
oldest observations are dropped.
4. Box-Jenkins: Box-Jenkins uses the auto correlative structure of sales data to develop an
autoregressive moving average forecast from past sales and forecast errors.
5. Trend line analysis: Trend line analysis fits a line to the sales data by minimizing the squared
error between the line and actual past sales values. This line is then projected into the future as
the forecast.
6. Decomposition: Decomposition breaks the sales data into seasonal, cyclical, trend and noise
components and projects each into the future.
7. Straight-line projection: Straight-line projection is a visual extrapolation of the past data,
which is projected into the future as the forecast.
8. Life-cycle analysis: Life-cycle analysis bases the forecast upon whether the product is judged
to be in the introduction, growth, maturity, or decline stage of the life cycle.
9. Simulation: Simulation uses the computer to model the forces, which affect sales: customers,
marketing plans, competitors, flow of goods, etc. The simulation model is a mathematical
replication of the actual corporation.
10. Expert systems: Expert systems use the knowledge of one or more forecasting experts to
develop decision rules to arrive at a forecast.
11. Neural networks look: Neural networks look for patterns in previous history of sales and
explanatory data to uncover relationships. These relationships are used to produce the forecast.
What qualitative methods are widely used in demand forecasting? Describe
briefly. BBA (Professional) 2013
2.38 CONFLICTS BETWEEN THE NPV AND IRR METHODS &

WAY TO RESOLVE THE PROBLEM
CONFLICTS
The NPV and IRR methods will return conflicting results when mutually exclusive projects differ
in size, or differences exist in the timing of cash flows. When mutually exclusive projects exhibit
these attributes, their NPV profiles will cross when plotted on a graph. This point at which they
cross is defined as the crossover rate, which happens because one projects NPV is more sensitive
to the discount rate caused by the differences in the timing of cash flows. In most cases, utilizing
either the NPV or IRR method will lead to the same accept-or-reject decision. An exception
exists when evaluating mutually exclusive projects with crossing NPV profiles and the cost of
capital is less than the crossover rate. When these conditions are present, the NPV and IRR
results will conflict in which project to accept or reject. Because the NPV method uses a
reinvestment rate close to its current cost of capital, the reinvestment assumptions of the NPV
method are more realistic than those associated with the IRR method.
NPV also has an advantage over IRR when a project has non-normal cash flows. Non-normal
cash flows exist if there is a large cash outflow during or at the end of the project. The presence
of non-normal cash flows will lead to multiple IRRs. Hence, the IRR method cannot be
employed in the evaluation process. Mathematically, this problem will not occur if the NPV
method is employed. The NPV method will always lead to a singular correct accept-or-reject
decision.
WAY TO RESOLVE THE PROBLEM

To compute NPV and apply the NPV rule, the authors of the reference textbook define a five-step
process to be used in solving problems:
1. Identify all cash inflows and cash outflows.
2. Determine an appropriate discount rate (r).
3. Use the discount rate to find the present value of all cash inflows and outflows.
4. Add together all present values. (From the section on cash flow additivity, we know that this
action is appropriate since the cash flows have been indexed to t = 0.)
5. Make a decision on the project or investment using the NPV rule: Say yes to a project if the
NPV is positive; say no if NPV is negative. As a tool for choosing among alternates, the
NPV rule would prefer the investment with the higher positive NPV.
Explain how different "reinvestment rate assumptions'' lead to conflicts between
the NPV and IRR methods & how can you resolve the problem?
2.39 GENERAL FORMULA OF NPV

NPV Calculation Permits Time Varying Discount Rates So far we assumed that the discount rate
remains constant over time. This need not be always the case. The NPV can be calculated using
time-varying discount rates. The general formula of NPV is as follows:
Where Ct is the cash flow at the end of year t, and rt, is the discount rate for year t. In even more
general terms NPV is expressed as follows:
Where Ct, is the cash flow at the end of year t, is the one period discount rate applicable to period
j, and n is the life of the project.
The discount rate may change over time for the following reasons:
(a) The level of interest rates may change over timethe term structure of interest rates sheds
light on expected rates in future,
(b) The risk characteristics of the project may change over time, resulting in changes in the cost
of capital,
(c) The financing mix of the project may vary over time, causing changes in the cost of capital.
Example: To illustrate, assume that you are evaluating a 5-year project involving software
development. We believe that the technological uncertainty associated with this industry leads to
higher discount rates in future.
Discuss the general formula of NPV (with an example) when discount rate vary over
time. BBA (Professional) 2013
2.40 PROBLEMS
BBA (PROFESSIONAL) 2010
Problem 1. Prepare a PRI by using 5-point scale and considering eight relevant factors with
appropriate weights. Limit the final score at 4.0 or at 10% lower or 10% higher than this figure.
Use imaginary figures where necessary.
SOLUTION DETERMINATION OF THE

PROJECT RATING INDEX
Relevant Factors Factor Rating Factor
Weight VG G A P VP Score
5 4 3 2 1
1. Input availability 0 25 0.75
2. Technical know-how 0.10 0.40
3. Reasonableness of cost 0.05 0.20
4. Adequacy of market 0.15 0.75
5. Complementary relationship with other products 0.05 0.20
6. Stability 0.10 0.40
7. Dependence on firm's strength 0.20 1.00
8. Consistency with governmental priorities 0.10 0.30
Rating Index 4.00

Problem 2. The sales of Biofuel Energy Ltd. during a 10 year period have been as follows:-
Period Sales Period Sales
1 10.000 6 15-000
2 12.000 7 14-000
3 11.000 8 12-500
4 13-000 9 13-500
5 12-000 10 14-500
Find the least squares regression line for the data given.
Solution Calculation for least squares regression line and trend value
Period Sales xy x2 Trend Value
x y yc = 10600 + 390.91x
1 10,000 10,000 1 10990.91
2 12,000 24,000 4 11381.82
3 11,000 33,000 9 11772.73
4 13,000 52,000 16 12163.64
5 12,000 60,000 25 12554.55
6 15,000 90,000 36 12945.46
7 14,000 98,000 49 13336.37
8 12,500 100,000 64 13727.28
9 13,500 121,500 81 14118.19
10 14,500 145,000 100 14509.10
X = 55 Y =1,27,500 XY = 7,33,500 X2 = 385
Thus the least squares regression line is
Where,
Yc = a + bX
xy
x y
n
b=
x 2
X 2

n
55 127500
733500
10
=
385
55
2
10
a=
y b x
n n

127500 55
= 390.91
10 10
yc = 10600 + 390.91x
BBA (PROFESSIONAL) 2010, 2008

Problem 3. The sales of a certain product during 14 year period have been as follows:
1 2000 8 4000
2 2200 9 3900
3 2100 10 4000
4 2300 11 4200
5 2500 12 4300
6 3200 13 4900
7 3600 14 5300
Find the least squares regression line for the data given above.
Period Sales xy x2 trend value
x y yc = 10600 + 390.91x
1 2000 2000 1 1811
2 2200 4400 4 2066
3 2100 6300 9 2320
4 2300 9200 16 2574
5 2500 12500 25 2828
6 3200 19200 36 3083
7 3600 25200 49 3337
8 4000 32000 64 3591
9 3900 35100 81 3845
10 4000 40000 100 4100
11 4200 46200 121 4354
12 4300 51600 144 4608
13 4900 63700 169 4862
14 5300 74200 196 5117
X = 105 Y =48,500 XY = 4,21,600 X2 = 1015
Where,
Yc = a + bX
xy
x y
n
b=
x 2
X 2

n
105 48,500
4,21,600
14
=
1015
105
2
14
a=
y b x
n n

48500 105
= 254.28
14 14
= 1557
yc = 1557 + 254.28x

Problem 4. Orion Infusion operates its business since 2001. The demand of its product was as
follows:
Year 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
Demand 17 18 25 23 30 40 36 56 45 60
Find out the forecasted demand for the year of 2013 using LS method.
Solution: Let year=X, demand= y, base year=2001

Calculation for forecasted demand for the year of 2013 using LS method
Year x y xy x2 trend value
X =X-2001 yc = 10600 + 390.91x
2001 0 17 0 0 13.72
2002 1 18 18 1 18.45
2003 2 25 50 4 23.18
2004 3 23 69 9 27.91
2005 4 30 120 16 32.64
2006 5 40 200 25 37.37
2007 6 36 216 36 42.10
2008 7 56 392 49 46.83
2009 8 45 360 64 51.56
2010 9 60 540 81 56.29
N = 10 x =45 y = 350 x y = 1965 x 2
=285
Thus the least squares regression line is Yc = a + bX
Where,
xy
x y
n
b=
x 2
X 2

n
45 350
1965
10
=
285
45
2
10
a=
y b x
n n

350 45
= 4.73
10 10
yc = 13.72 + 4.73x
If year X=2013, x=X-2001=2013-2001=12 then,
yc = 13.72 + 4.73x
= 13.72 + 4.73
= 70.48

Problem 5. The sales of BASIC Ltd. during a 10 year period have been as follows:- 2013
2001 5100 2006 7000
2002 5200 2007 7300
2003 6200 2008 8200
2004 5300 2009 8500
2005 5400 2010 8700
Assume that the forecast for 2001 was 5100. If is equal to 0.2, derive the forecasts for the year2002 to
2010 using the exponential smoothing method.
Solution: Let year=X, demand= y, base year=2001

Calculation for forecasted demand for the year of 2013 using LS method
Year (X) x = X-2001 y(St) xy x2
yC
2001 0 5100 0 0 4,697
2002 1 5200 5200 1 5,140
2003 2 6200 12400 4 5,583
2004 3 5300 15900 9 6,026
2005 4 5400 21600 16 6,469
2006 5 7000 35000 25 6,912
2007 6 7300 43800 36 7,355
2008 7 8200 57400 49 7,798
2009 8 8500 68000 64 8,241
2010 9 8700 78300 81 8,684
N = 10 x =45 y = 66900 xy = x 2
337600 =285
Thus the least squares regression line is Yc = a + bX
Where,
xy
x y
n
b=
x 2
X 2

n
45 66900
337600
10
=
285
45
2
10
a=
y b x
n n

66900 45
= 443.03
10 10
yc = + x
So, The least squares regression line for the data given is, yc = 13.72 + 4.73x
In general, in exponential smoothing the forecast for x+1 is

Fx+1=Fx+ ex
F1 is given to be 5200 and is given to be 0.2
The forecasts for periods are calculated below:
Period Data Forecast Error Forecast for t + 1

x Sx (Fx) e=Sx-Fx
Fx+1=Fx+ ex
0 5,100 4,697 403 F1=4,697+0.2(403) = 552.0
1 5,200 5,140 60 F2=5,140+0.2(60) = 5152
2 6,200 5,583 617 F3 =5,583+0.2(617) = 5,706.4
3 5,300 6,026 -726 F4 =6,026+0.2(-726) = 5,880.8
4 5,400 6,469 -1,069 F5 =6,469+0.2(-1,069) = 6,255.2
5 7,000 6,912 88 F6 =6,912+0.2(88) = 6,929.6
6 7,300 7,355 -55 F7 =7,355+0.2(-55) = 7,245
7 8,200 7,798 402 F8 =7,798+0.2(402) = 7,878.4
8 8,500 8,241 259 F9=8,241+0.2(259) = 8,292.8
9 8,700 8,684 16 F10 =8,684+0.2(6) = 8,685.2

Problem 6. The sales of Sarnia Home Appliance Inc. during a 10 years period have been as follows
:
1 5,000 6 7,000
2 5,500 7 7,500
3 6,000 8 8,000
4 5,500 9 8,400
5 6,500 10 9,000
Find the least squares regression line for the data given.
Period Sales xy x2 trend value
x y yc = 5673.33 + 212.12x
1 5000 5000 1 5885.45
2 5500 1100 4 6097.57
3 6000 18000 9 6309.69
4 5500 22000 16 6521.81
5 6500 32500 25 6733.93
6 7000 42000 36 6946.05
7 7500 52500 49 6946.05
8 8000 64000 64 7370.29
9 8400 75600 81 7582.41
10 9000 81000 100 7794.53
X = 55 Y =68400 XY = 393700 X2 = 385
Where,
Yc = a + bX
xy
x y
n
b=
x 2
X 2

n
55 68400
393700 -
10
=
385
55
2
10
a=
y b x
n n

68400 55
= 212.12
10 10
= 5673.33
yc = 5673.33 + 212.12x
BBA (PROFESSIONAL) 2012, 2010 MODIFIED

Problem 7. The Balance Sheet of Unicom Ltd. at the end of 2012 is at follows:
Liabilities Assets
Particulars Amount in Particulars Amount in
Million Taka Million Taka
Share Capital 5 Fixed Assets 11
Reserve & Surplus 4 Investments 0.5
Secured Loans 4 Current Assets
Unsecured Loans 3 Cash 1
Current Liabilities' 6 Receivable 4
Provisions 1 Inventories 6.5 11.5
Total: 23 23
Projected Income Statement and the distribution of earnings are given below:
Particulars Amount in Million
Sales 25
COGS 19
Depreciation 1.5
EB1T 4.5
Interest 1.2
Profit before Tax 3.3
Tax 1.8
Net profit 1.5
Dividends 1.0
Retained Earnings 0.5
During the year 2013, the firm plans to raise a secured term loan of 1.5 million, repay a previous
terms loan to the extent of 0.5 million. Current liabilities and provisions would increase by 1.0%.
Further, the firm plans to acquire fixed assets worth 1.5 million and raise its inventories by 0.5
million: Receivable is expected to increase by 5%. The level of cash would be the balancing
amount in the projected balance sheet. Given the above information, prepare the following:
(a) Projected Cash-flow Statement.
(b) Projected balance sheet.
Solution: Unicom Ltd.
Projected Cash-flow Statement
Particulars Amount
Tk
Source of fund:
EBIT 45,00,000
Depreciation 15,00,000
Increase in secured loan 5,00,000
Increase in current liability 3,00,000
Increase in provision 50,000
Total sources of fund (A) 68,50,000
Disposition of fund:
Capital expenditure (Fixed asset) 15,00,000
Increase in working capital 7,00,000
Interest 12,00,000
Tax 18,00,000
Dividend 10,00.000
Total deposition of fund (B) 62,00,000
Opening balance of cash in hand and bank 10,00,000
Net surplus 6,50,000
Closing balance of cash in hand and bank. 16,50,000
Unicom Ltd.
Projected Balance Sheet
Liability Amount Assets Amount
Tk. Tk.
Share capital (Opening) 50,00,000 Fixed asset 1,10,00,000
Reserves 45,00,000 Investment 5,00,000
Secured loan 45.00,000 Current asset:
Unsecured loan(Opening) 30,00,000 Cash 16,50,000
Current liability 63,00.000 Receivable 42,00,000
Provision 10,50,000 Inventories 70,00,000
2,43.50,000 2,43.50,000
Working Notes:
Items Calculation Amount
Tk
Increase in secured loan 10,00,000-5,00,000 5,00,000
60,00,00 5%
10,00,000 5%
Increase in working capital 5,00,000+2,00,000 7,00,000
Net surplus 68,50,000-62,00,000 6,50,000
Reserves & Surplus (Opening +Retained earnings) =40,00,000+5,00,000 45,00,000
Secured loan (Opening+Additiona1-repayment)=40,00,000+10,00,000- 5,00,000 45,00,000
Current liability 60, 00,000+60, 00,000 5% 63,00,000
Provision 10,50,000
10, 00,000+10, 00,000 5%)
Cash 16,50,000
10,00,000+6,50,000+10,00,000 20%
Receivable 40,00,000+2,00,000 42,00,000
Inventories 65,00,000+5,00,000 70,00,000
BBA (PROFESSIONAL) 2011 MODIFIED

Problem 8 The Balance Sheet and income statement of Gazi Electronics Ltd. at the end of 2011 is
as follows:
Liabilities Assets
Particulars Amount ('000) Particulars Amount ('000)
Share Capital 5,000 Fixed Assets 11,000
Reserve & Surplus 4,000 Investments 500
Secured Loans 7,000 Current Assets
Current Liabilities 6,000 Cash 1,000
Provisions 1,000 Receivables 4,000
Inventories 6,500
11,500
Total 23,000 23,000
Projected Income Statement and the distribution of earnings is given below :
Particulars Amount in
Million
Sales 25,000
COGS . 19,000
Depreciation 1,500
EB1T 4,500
Interest 1,200
Tax 1,800
Net profit 1,500
Dividends 1,000
Retained Earnings 500
During the year 2012, the firm plans to raise a secured term loan of 100 thousand, repay a
previous terms loan to the extent of 50 thousand. Current liabilities and provisions would increase
by 5%. Further, the firm plans to acquire fixed assets worth 150 thousand and raise its inventories
by 50 thousand: Receivable is expected to increase by-5%. The level of cash would be the
balancing amount in the projected balance sheet-Prepare the following:
(i) Projected Cash-flow Statement.
(ii) Projected balance sheet.

Particulars Amount
Tk
Source of fund:
EBIT 45,00,000
Interest 12,00,000
Tax 18,00,000
Dividend 10,00.000
Unicom Ltd.
Tk. Tk.
2,43.50,000 2,43.50,000
Working Notes:
Tk
60,00,00 5%
10,00,000 5%
Net surplus 68,50,000-62,00,000 6,50,000
Provision 10,50,000
10, 00,000+10, 00,000 5%)
Cash 16,50,000
10,00,000+6,50,000+10,00,000 20%
Receivable 40,00,000+2,00,000 42,00,000
Inventories 65,00,000+5,00,000 70,00,000
BBA (PROFESSIONAL) 2013 MODIFIED

Problem 9 The Balance Sheet and income statement of Gazi Electronics Ltd. at the end of 2011 is
as follows:
Liabilities Assets
Particulars Amount ('000) Particulars Amount ('000)
Share Capital 5,000 Fixed Assets 11,000
Reserve & Surplus 4,000 Investments 500
Secured Loans 7,000 Current Assets
Current Liabilities 6,000 Cash 1,000
Provisions 1,000 Receivables 4,000
Inventories 6,500
11,500
Total 23,000 23,000
Projected Income Statement and the distribution of earnings is given below :

Particulars Amount in
Million
Sales 25,000
COGS . 19,000
Depreciation 1,500
EB1T 4,500
Interest 1,200
Tax 1,800
Net profit 1,500
Dividends 1,000
Retained Earnings 500
During the year 2012, the firm plans to raise a secured term loan of 100 thousand, repay a
previous terms loan to the extent of 50 thousand. Current liabilities and provisions would increase
by 5%. Further, the firm plans to acquire fixed assets worth 150 thousand and raise its inventories
by 50 thousand: Receivable is expected to increase by-5%. The level of cash would be the
balancing amount in the projected balance sheet-Prepare the following:
(i) Projected Cash-flow Statement.
(ii) Projected balance sheet.

Particulars Amount
Tk
Source of fund:
EBIT 45,00,000
Interest 12,00,000
Tax 18,00,000
Dividend 10,00.000
Unicom Ltd.
Tk. Tk.
2,43.50,000 2,43.50,000
Working Notes:
Tk
60,00,00 5%
10,00,000 5%
Net surplus 68,50,000-62,00,000 6,50,000
Provision 10,50,000
10, 00,000+10, 00,000 5%)
Cash 16,50,000
10,00,000+6,50,000+10,00,000 20%
Receivable 40,00,000+2,00,000 42,00,000
Inventories 65,00,000+5,00,000 70,00,000

Problem 10. Wifezone Ltd. is considering two mutually exclusive projects, X and Y. Projects X involves
an outlay of Tk.200 million which will generate an expected cash inflow of Tk. 50 million per year for 5
years. Projects Y calls for an outlay of Tk.100 million which will produce an expected cash inflow of Tk.
25 million per year for 5 years. The companies cost of capital is 15 percent. What is NPV of the differential
project?
Solution: Calculation for NPV of the differential projects

CFAT (million Tk.) PV Factor PV of CAFAT (million Tk.)
Year X Y @15% X Y
0 -200 -100 1 -200 -100
1-5 50 25 3.3522 167.61 83.805
NPV -32.39 -16.195
BBA (PROFESSIONAL) 2008, 2014

Problem 11. Sky Limited Company is considering two mutually exclusive investments, project P and
project Q. The expected cash flows of these two projects are as follows:
Year Project P Project Q
Taka Taka
0 (1000) (1600)
1 (1200) 200
2 (600) 400
3 (250) 600
4 2000 800
5 4000 100
Required:
(i) Construct the NPV profiles for projects P & Q (k=10%).
(ii) What is the IRR of each project?
(iii) What project should be accepted and why?
Solution:
Table showing relevant calculation
year P Q PV factor @ Project P Project Q
NCB NCB PV of NCB PV of NCB
20% 10% 5% 20% 10% 5% 20% 10% 5%
0 -1000 -1600 1 1 1 -1000 -1000 -1000 -1600 -1600 -1600
1 -1200 200 0.8333 0.9091 0.9524 -1000 -1091 -1143 167 182 190
2 -600 400 0.6944 0.8264 0.9070 -417 -496 -544 278 331 363
3 -250 600 0.5787 0.7513 0.8638 -145 -188 -216 347 451 518
4 2000 800 0.4823 0.6830 0.8227 +965 1645 1645 386 546 658
5 4000 100 0.4019 0.6209 0.7835 +1608 2484 3134 40 78 78
NPV = - 11 1354 1876 -382 -12 207
(i) NPV of project P at 10% cost of capital =1354
NPV of project P at 10% cost of capital = -12
Table showing NPV profile for projects at different discount rates

Projects Project P Project Q
PV of NCB PV of NCB
Discount rates 20% 10% 5% 20% 10% 5%
NPV - 11 1354 1876 -382 -12 207
Construction of NPV profile for project P at different discount rates
Construction of NPV profile for project Q at different discount rates

(ii) IRR of project P =
=
= .10+0.0992
=.1992=19.92%
IRR of project Q =
=
= .05+0.0472
=.0972=9.72%
(ii) Project P should be accepted because its IRR is much higher then project Q.

Problem 12: Safura Ltd. is considering two mutually exclusive investments, Project-Five Star and
Project-Seven Star. The expected cash-flows of these projects are as follows :
Year Five Star Seven Star .
0 Tk. (20,00,000) Tk. (20,00,000)
1 15,00,000 15,00,000
2 (6,00,000) 6,00,000
3 12,00,000 5,00,000
4 8,00,000 3,00,000
Required:
(i) Find NPV of the each project using 15% cost of capital.
(ii) Construct the NPV profiles for projects at different discount rates.
(iii) What is the IRR of each project?
Solution: Table showing relevant calculation

year Five Star Seven PV factor @ Five Star Seven Star
NCB Star PV of NCB PV of NCB
NCB 25% 15% 5% 25% 15% 5% 25% 15% 5%
0 -20,00,000 -20,00,000 1 1 1 -20,00,000 -20,00,000 -20,00,000 -20,00,000 -20,00,000 -20,00,000
1 15,00,000 15,00,000 .8000 .8696 0.9524 1200000 1304400 1428600 1200000 1304400 1428600
2 -6,00,000 6,00,000 .6400 .7561 0.9070 -384000 -453660 -544200 384000 453660 544200
3 12,00,000 5,00,000 .5120 .6575 0.8638 614400 789000 1036560 256000 328750 431900
4 8,00,000 3,00,000 .4096 .5716 0.8227 327680 457280 658160 122880 171480 246810
NPV = -241920 97020 694720 -37120 258290 651510
(i) NPV of project P at 10% cost of capital =97020
NPV of project P at 10% cost of capital = 258290
(ii) Table showing NPV profile for projects at different discount rates
Projects Five Star Seven Star
PV of NCB PV of NCB
Discount rates 25% 15% 5% 25% 15% 5%
NPV -241920 97020 694720 -37120 258290 651510
Construction of NPV profile at different discount rates
Five Star Seven Star
(iii) Calculation for IRR

Five Star Seven Star
IRR = IRR =
= =
= .15+0.0286 = .15+0.0874
=.1786=17.86% =.2374=23.74%

Problem 13. The projected cash-flows of these projects are as follows:
Year: 0 1 2 3 4 5
LDP: (40,000) (200) 1,000 3,500 20,000 40,000
AP: (25,000) 2,000 4,000 8,000 10,000 20,000
Requirements:
(i) Which project would you choose if the cost of capital is 13%?
(ii) What is the IRR of project LDP?
(iii) Construct the NPV profile for project LDP.

year LDP AP NCB PV factor @ PV of NCB
LDP AP
NCB
20% 13% 5% 20% 13% 5% 13%
0 -40,000 -25,000 1 1 1 -40,000 -40,000 -40,000 -25,000
1 -200 2,000 0.8333 0.8850 0.9524 -1,667 -1,77 -190 1,770
2 1,000 4,000 0.6944 0.7831 0.9070 694 783 907 3,132
3 3,500 8,000 0.5787 0.6931 0.8638 2,025 2,426 3,023 5,545
4 20,000 10,000 0.4823 0.6133 0.8227 9,646 12,266 16,454 6133
5 40,000 20,000 0.4019 0.5428 0.7835 16,076 21,712 31,340 10,856
NPV = -13,226 -2,990 11,534 2,436
(i) NPV of project LDP at 13% cost of capital = -13,226
NPV of project AP at 13% cost of capital = 2,436
At 13% cost of capital I would choose project AP, because NPV is positive.
(ii) Calculation for IRR of project LDP
IRR =
=0
= 0.05+0.0635
=0.1135=11.35%
(iii) Table showing NPV profile for projects LDP at different discount rates
PV of NCB
Discount rates 20% 13% 5%
NPV -241920 97020 694720
Construction of NPV profile at different discount rates


Problem 14: Green Grasses Ltd. has estimated the cash-flows over the 4 year lives for the
following projects namely Project-Roof and Backyard :
End of Year
0 1 2 3 4
Project Roof ($5,000) $2,000 $2,000 $2,000 $2,000
Project Backyard ($5,000) $3,000 0 0 $6,000
(1) Determine the net present value-for each project at discount rate of 0, 5, 10 and 20 percent.
(2) Determine the internal rate of return for each project.
(3) Draw the NPV Profiles for the projects in a single graph.

year Project Project PV factor @ Project Roof Project Backyard
Roof Backyard PV of NCB ($) PV of NCB($)
5% 10% 20% 5% 10% 20% 5% 10% 20%
NCB NCB
0 -5,000 -5,000 1 1 1 -5,000 -5,000 -5,000 -5,000 -5,000 -5,000
1 2,000 3,000 0.9524 0.9091 0.8333 1,905 1,818 1,667 2,857 2,727 2,500
2 2,000 0.9070 0.8264 0.6944 1,814 1,653 1,389 - - -
3 2,000 0.8638 0.7513 0.5787 1,728 1,503 1,157 - - -
4 2,000 6,000 0.8227 0.6830 0.4823 1,645 1,366 965 4,936 4,098 2,894
3,000 4,000 NPV = 2,092 1,340 178 2,793 1,825 394
(i) The net present value-for each project at discount rate of 0, 5, 10 and 20 percent
0% 5% 10% 20%
NPV of project Roof 3,000 2,092 1,340 178
NPV of project Backyard 4,000 2,793 1,825 394
(ii) Calculation for IRR, Let discounting rate is 25%

Table showing relevant calculation
year Project Roof Project Backyard PV factor PV of NCB ($)
NCB NCB @25% Roof Backyard
0 -5,000 -5,000 1 -5,000 -5,000

1 2,000 3,000 .8000 1600 2,400
2 2,000 - .6400 1,280
3 2,000 - .5120 1,024
4 2,000 6,000 .4096 819 2,458
-277 -142
(iii) Calculation for IRR
Project Roof Project Backyard
IRR = IRR =
= =
= .20+0.0305 = .20+0.0368
=.2305=23.05% =.2368=23.68%
(iii) Construction of NPV profile at different discount rates

Problem 15: You want buy a flat from Domicile Ltd. That's why you need to borrow Tk. 20,
00,000. You have approached to a house building financing company which charges 12% interest.
You can pay Tk.3, 00,000 per year towards loan amortization. How long it will take to repay the
loan?
Solution: Given that,

Present Value of the flat, P= Tk.20,00,000
Annual Installment, A= Tk.3,00,000
Interest Rate, r = 0.12
No. of years, n=?
= 14.12 years

Problem 16: Suppose someone offers you the following financial contract. If you deposit Tk.
20,000 with him he promises to pay Tk. 4,000 annually for 10 years. What rate of interest would
you earn on this deposit?
Solution: We can use IRR method to calculate rate of interest.

Let rate of interest is 10% or 20%
CALCULATION FOR P.V. OF NCB
Year NCB P.V. Factor P.V. of NCB
@ 10% @20% @ 10% @%
0 -20,000 1 1 -20,000 -20,000
1-10 4000 6.1446 4.1925 24,578 16,770
4,578 -3,230
+0.0586
586
5.86%
Ans. Rate of interest was= 15.86%

Problem 17: How much would a deposit of Tk. 5,000 at the end of 5 years be, if the interest rate
is 12 per cent and if the compounding is done quarterly?
Solution: Present value of deposit,
Ans. Tk. 74,387.50

Problem 18 Suppose, a house has been constructed by ADDL costing Tk. 20 lakh. You could
manage equity capital from your father's pension money amounting Tk. 5 lakh. Of the remaining
Tk. 10 lakh could be borrowed from Bangladesh House Building Finance Corporation (BHBFC)
to be paid over next thirty years in monthly equal installments. Trust Bank also agreed to lend
you Tk. 5 lakh to be repaid over next Fifteen years in equal monthly installments. Interest is 12
percent for both BHBFC and Trust Bank. How much should be paid in each installment to (A)
Bangladesh House Building Finance Corporation and (B) Trust Bank?
Solution:
(A) Each installment should be paid in to Bangladesh House Building Finance Corporation,
PV
Instalment
1 1

r r r
mn
m m 1 m
10,00,000

1 1
1230
.12 .12 .12
1
12 12 12
10,00,000

1 1

0.01 0.011.01 360
10,00,000
Tk.10286.13 Ans.
97.218331
(A) Each installment should be paid in to Trust Bank,
PV
Instalment
1 1

r r r
mn
m m 1 m
5,00,000

1 1
1215
.12 .12 .12
1
12 12 12
5,00,000

1 1

0.01 0.011.01 180
5,00,000
Tk.6000.84 Ans.
83.321664
BBA (PROFESSIONAL) 2014 (MODIFIED)
Problem 19 International Cyber Net Ltd. is determining the cash-flows for a project involving
replacement of an old machine by a new machine. The old machine bought a few years ago has a
book value of Tk. 400,000 and it can be sold to realize a post-tax salvage value Tk.500,000. It has
a remaining life of five years after which its net salvage value is expected to be Tk. 160/000. It is
being depreciated annually at a rate of 15 percent under the written down value method. The net
working capital required for the old machine is Tk. 400,000. The new machine costs
Tk.1,600,000. It is expected to fetch a net salvage value of Tk.800,000 after 5 years
when it will no longer be required the depreciation rate applicable to it is 15 percent under the
written down value method. The net working capital required for the new machine is
Tk.500,000. The new machine is expected to bring a saving of Tk.25,143 annually in
manufacturing costs (other than depreciation). The tax rate applicable to the firm is 30 percent
Solution:
Cash Flows for a Replacement Project
Years (Tk. In000)

PM Chapter-2

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Chapter 2: Project Appraisal 17

2.01 MARKET APPRAISAL

What do you mean by appraisal?

2.02 PROJECT FEASIBILITY STUDY

According to Eric Mc Connell, A Project Feasibility Study is an exercise that involves

According to Georgakellos, D. A. & Marcis, A. M., The feasibility study is an evaluation

What is project feasibility study? BBA (Professional) 2009, 2011, 2012,1014

2.03 PROJECT RATING INDEX

What is Project Rating Index (PRI)? BBA (Professional) 2010

2.04 SCHEMATIC DIAGRAM OF FEASIBILITY STUDY

Single out the big ticket project

2.05 FACTS OF PROJECT FEASIBILITY STUDY

2. Technical analysis: Examination of the technical and engineering characteristics of a project

2.06 SOURCES OF POSITIVE NET PRESENT VALUE

2. Product Differentiation: Effective advertising and superior marketing, exceptional service,

4. Marketing Reach: A penetrating marketing reach is an important source of competitive

5. Technological Edge: Technological superiority enables a firm to enjoy excellent returns. A

2.07 STEPS INVOLVED IN MARKET AND DEMAND ANALYSIS

2.08 GENERAL SOURCES OF SECONDARY INFORMATION

Published Sources Unpublished Sources

Government Private Semi-official Commissions International

2.10 CHARACTERISTICS OF THE MARKET

2.11 DEMAND FORECASTING

2.12 DEMAND FORECASTING METHODS

2.13 MEANS OF FINANCING

2.14 KEY BUSINESS CONSIDERATIONS

2.15 MEASUREMENT OF PRICE ELASTICITY OF DEMAND

(4) Arc Elasticity: Arc Elasticity is a measure of the average

How is price elasticity of demand measured? BBA (Professional) 2010

2.16 MEASUREMENT OF INCOME ELASTICITY OF DEMAND

How is income elasticity of demand measured? BBA (Professional) 2010

2.17 CONSIDERATION WHILE ESTIMATING SALES REVENUE

2.18 PROJECTS, PROGRAMMED TASKS AND ACTIVITY PACKAGES

2.19 NET PRESENT VALUE (NPV)

2.20 MIRR IS BETTER

2.21 ADDITIVE PROPERTY OF NPV

IMPLICATIONS OF THE ADDITIVE PROPERTY OF NPV

2.22 FACTORS INFLUENCING THE CHOICE OF TECHNOLOGY

2.23 TECHNICAL AND ENVIRONMENTAL ANALYSIS

2.24 COST OF PROJECT

11. Provision for contingencies

4. Technical know-how and Engineering fees: Often it is necessary to engage technical

Define cost of a project? What are the components/factors of cost of a project?

2.25 PROPERTIES OF THE NPV RULE

2.26 PROBLEMS WITH IRR

2.27 DIFFERENT PHASES OF CAPITAL BUDGETING

2.28 SOCIAL COST BENEFIT ANALYSIS

2.29 RATIONALE FOR SCBA

2.30 UNIDO APPROACH OF PROJECT APPRAISAL

2.31 STAGES OF UNIDO APPROACH

2.32 UNIDO VS LM APPROACH

2.33 SHADOW PRICING

2.34 BASIC ISSUES OF SHADOW PRICING

2.36 WILLINGNESS TO PAY (WTP)

Consumers willingness to pay

2.37 QUANTITATIVE FORECASTING TECHNIQUES

2.38 CONFLICTS BETWEEN THE NPV AND IRR METHODS &

WAY TO RESOLVE THE PROBLEM

2.39 GENERAL FORMULA OF NPV

SOLUTION DETERMINATION OF THE

BBA (PROFESSIONAL) 2009

BBA (PROFESSIONAL) 2010, 2008

BBA (PROFESSIONAL) 2011