COURSE MANUAL

Programme: BBAI. P. University (Session 200912) Semester Subject Code : VI : Project Planning & Evaluation : BBA - 304

Complied By : (Prof. Pradip K. Mukherjee) Dept. of Management

Approved By : (Prof. S. K. Dogra) H.O.D. (Management) BBA VI Semester, I.P. University

1

304 PROJECT PLANNING & EVALUATION Unit I :

1.0 Capital Investment: Capital expenditure is a commitment of current resources in order to secure a stream of benefits in future years. The value of benefits received is measured not only in terms of benefits received but also the timing of their receipt. The net benefits of capital expenditure depend upon the quality of investment decisions. The quality is judged by weighing the benefits against risks & uncertainties. 1.1 Importance Capital investment decision is one of the most important decision taken by any organization must be taken with due care because they involve high stakes. The importance is arising from 3 inter-related reasons: Long-term Effects: The consequences of capital investment decisions have a far reaching effect. The present activities & functions are largely governed by capital expenditures in the past. Similarly present capital investment decisions provide framework for future activities. Irreversibility: A wrong capital investment decision often cannot be reversed without incurring a substantial loss. The market for used capital goods / equipment especially tailor-made to meet specific requirements may be virtually non-existent. Once such an equipment is acquired, reversal of decision may lead to scrapping the capital equipment leading to substantial loss. Substantial Outlays: Capital costs tend to increase with advanced technology. Capital expenditures usually involve substantial outlays.
1.2 Difficulties The difficulties posed can be broadly described as follows: Uncertainty: A capital investment decision involves costs & benefits that

extend into the future which is difficult to predict exactly. This is associated with measurement problems. Risk element: Benefits from capital expenditure are subject to risk like judgmental error, wrong estimation, incomplete data, unpredictability of events, etc. 2.0 Types of Capital Investment: This are often classified by different companies in different ways for planning & control. 2.1 Physical, Monetary & Intangible Assets Physical Assets are tangible investments like land, building, plant, machinery, vehicles, computers, etc. Monetary Assets are deposits, bonds, shares, etc. Intangible Assets are different from physical assets & financial claims. They represent outlays on research, training & development, market development, etc. that are expected to generate benefits over a period of time.
2

2.2 Other categories of investments Strategic investment has a significant impact on the direction of the firm. Tactical investments implement a current strategy as efficiently or profitably as possible. Mandatory investment is a capital expenditure required to comply with statutory requirements viz. fire-fighting equipment, pollution control measures, canteen facility, medical aid, etc. Replacement investment is meant to replace worn out or obsolete equipment with new modern equipment to reduce operating costs, increase productivity, improve quality, etc. Expansion investment is to increase the capacity to cater growing demand. Diversification investment is aimed at producing new products towards growth of the organization. R & D investment is focused to develop new products & improved processes to sharpen the technological edge of the company. 3.0 Phases of Capital Budgeting: Capital budgeting may be divided into 6 broad phases 1. Planning: 2. Analysis: 3. Selection: 4. Financing: 5. Implementation: 6. Review. 3.1 Planning is concerned with broad investment strategy & preliminary screening of project proposals. The investment strategy shows the broad areas or types of investment the firm plans to undertake. Once a project proposal is identified a preliminary project analysis is done. This exercise is meant to assess 1.1 Whether the project is prima-facie viable to justify a feasibility study ? 1.2 What aspects of the project are critical to its viability requiring in-depth investigation. 3.2 Analysis If from the preliminary screening project is prima-facie acceptable, a detailed analysis of the marketing, technical, financial, economic & ecological aspects is undertaken. 3.3 Selection A wide range of appraisal criteria is available to judge the suitability of the project. They are divided into 2 broad categories : (a) Non-discounting criteria viz. pay back period, accounting rate of return, etc. (b) Discounting criteria viz. net present value, internal rate of return, benefit cost ratio, etc. Criterion Payback period PBP Accept PBP < Target period Reject PBP > Target period
3

Accounting rate of return ARR Net present value NPV Internal rate of return IRR Benefit cost ratio - BCR

ARR > Target rate NPV > 0 IRR > Cost of capital BCR > 1

ARR < Target rate NPV < 0 IRR < Cost of capital BCR < 1

3.4 Financing Once a project is selected, suitable financing arrangements have to be made. Two broad sources of finance for a project are equity & debt. Equity (referred to shareholders funds on balance sheets) consists of paid-up capital, share premium & retained earnings. Debt (referred to as loan funds on balance sheets) consists of term loans, debentures & working capital advances. Flexibility, risk, income, control & taxes (FRICT) influence the capital structure (debt-equity ratio) decision & the choice of specific instruments of financing. 3.5 Implementation For an industrial project involving setting up of manufacturing facilities consists of several stages: (a) Design & engineering Site probing, acquisition of technology, plant design & engineering, selection of specific machineries & equipment, prepare specifications for procurement. (b) Purchasing & contracting Selection of vendors, issue of enquiries / tenders, evaluation, placement of orders, receipt / issue of materials, etc. Construction & erection Site preparation, civil works, erection & installation of machinery & equipment, etc. (d) Commissioning Start up the plant & stabilize operation. (e) Training Training of all level of employees to be able to take up responsibility that starts from the beginning. Translating an investment proposal into a concrete project is a complex, timeconsuming and associated with risk. Delays in implementation, which are common, can lead to substantial cost over-runs. For implementation of a project without time & cost over-run maintaining specific quality requirements the following are helpful: Adequate formulation of Projects Responsibility accounting Network techniques for monitoring 3.6 Review Performance review must be done periodically to compare actual performance with planned one. In case of deviation or shortfall corrective actions are required to be taken. 4.0 Levels of Decision Making: There are 3 levels of decision making Operating, Administrative & Strategic. Operating decisions are short term with minor resource commitment, routine matters taken by lower level management.
4

Administrative decisions are medium term with moderate resource commitment & semi-structured taken by middle level management. Strategic decisions have a long term impact with major resource commitment & unstructured taken by top level management. This influences a larger part of the system & is difficult to undo once implemented. 5.0 Facets of Project Analysis: 5.1 Market Analysis is concerned with the aggregate demand of the proposed product/service in future and future market share of the product under appraisal. The market analysts collect a wide variety of information as mentioned below & decide appropriate forecasting methods: Past consumption trends & present consumption level. Past & present supply position. Production possibilities & constraints. Imports & exports. Structure of competition. Cost parameters. Elasticity of demand. Consumer behavior, intentions, motivations, attitudes, preferences & requirements. Distribution channels & marketing policies in use. Administrative, technical & legal constraints.
5.2 Technical Analysis covers technical & engineering aspects of a project

viz. choices of location, size, process, etc. Selection of suitable production process. Scale of operation. Availability of raw-materials, power & other infrastructure. Selection of appropriate equipment & machineries. Provision for effluent treatment & other legal/social requirements. Realistic schedule. 5.3 Financial Analysis ascertains financial viability to generate return expectations of the capital after meeting liabilities. It analyses: Investment outlay & cost of the project. Means of financing. Cost of capital. Projected profitability. Break-even point. Cash flow. Level of risk.
5

5.4 Economic Analysis also referred to as social cost benefit analysis is concerned with judging a project from the larger social point of view. It focuses o What are the direct economic benefits & costs of the project measured in terms of shadow (efficiency) prices & not in terms of market prices ? o What would be the impact of the project on the distribution of income and level of savings / investment in the society ? o What would be the contribution of the project towards fulfillment of the certain merits like self-sufficiency, employment, social order, etc. ? 5.5 Ecological Analysis should be done particularly for major projects having significant ecological implications with respect to pollution, soil erosion, etc. viz. power plants, chemicals, fertilizers, refineries, steel plants, irrigation schemes, etc. The key questions are What are the likely damage to the environment ? What are the cost of restoration measures required to ensure that the damage to the environment is contained within acceptable limits ? Summary of Key Issues in different types of Project Analysis ------ Potential Market Market Analysis ------------- Market Share ------ Viability Technical Analysis ---------- Choices ------ Risk Financial Analysis ----------- Return ------ Benefits & Costs in shadow prices Economic Analysis---------- Other Impacts ------ Environmental Damage Ecological Analysis---------- Restoration Measures 6.0 Feasibility Study: is concerned with planning, analysis & evaluation, selection and financing involving market, technical, financial, economic & ecological analysis. Here the viability of the investment is evaluated.
6

7.0 Objective of Capital Budgeting:

Capital budgeting is a part of strategic planning. The objectives is to maximize the market value of the firm to its shareholders or shareholders wealth maximization. Identification of investment opportunities with merit. It involve cost of capital components Debt & Equity in making decisions of raising & investing new capital. This is very important to organization future. 8.0 Common weaknesses in Capital Budgeting: The quality of investment decisions are often impaired due to various deficiencies in capital budgeting like 8.1 Poor integration between strategy & capital budgeting. 8.2 Deficiencies in analytical techniques: Base case is poorly identified For evaluating a project, the base case or status quo scenario has to be specified i.e. what happens to the firm without the project. Risk is treated inadequately Options are not properly evaluated Lack of uniformity in assumptions in multidivisional companies, project proposals coming from different divisions tend to make varying assumptions about economy growth rate, inflation rate, residual value, capital cost, etc. Ignorance of side effects 8.3 No linkage between compensation & financial measures: Companies often use discounted cash flow criteria like NPV & IRR for project selection but link compensation to accounting measures like profit. 8.4 Reverse financial engineering the quality of information used is compromised to fulfill certain criteria laid down by the firm. 8.5 Weak integration between capital & expense budgeting: It is often done independently. 8.6 Inadequate post audits to compare actual performance with planned performance.

Capital Allocation Framework:

Capital is scarce & must be allocated across competing claims very judiciously. As such the key responsibility of top management is concerned with capital allocation
7

decisions. A good corporate investment program can mean sustained growth; failure to invest wisely can impede growth or even threaten companys survival. Key Criteria : Capital budgeting may be viewed as a 2-stage process. In the 1st stage, promising growth opportunities are identified through strategic planning techniques and in the 2nd stage, individual investment proposals are analyzed & evaluated in details to determine their worth. Elementary Investment Options : The strategic planning techniques & approaches aimed at identifying promising growth opportunities are basic long term goals & objective of an enterprise and the adoption of courses of action & the allocation of resources necessary for carrying out those goals. Thus strategy involves matching firms strengths & weaknesses with the opportunities & threats present in the external environment. Internal Analysis Environmental Analysis Technical know-how Customers Manufacturing capacity Competitors Marketing & Distribution Capability Regulation Logistics Infrastructure Financial Resources Social/Political Environment Strengths & Weaknesses Opportunities & Threats Determine core capabilities Identify opportunities ______________________________________________________________ Firms Strategy match between Core Capabilities & External Opportunities

Portfolio Planning Models: In multi-business firms allocation of resources across various units / departments is a key strategic decision. Portfolio planning models have been developed to guide the process of strategic planning & resource allocation viz. BCG matrix, Stoplight matrix & McKinsey matrix.
BCG matrix Developed by Boston Consulting Group, this classifies the

various businesses in a firms portfolio on the basis of relative market share and relative market growth rate as shown below: Market share High Low _____________________________
8

Market growth rate

High

Stars ? _____________________________ Low Cash Cows Dogs _____________________________

Stars - Businesses which enjoy a high market share & a high growth rate. They earn high profits but require additional commitment of funds for expansion of their activities. Eventually as growth declines & additional investment needs diminish, stars become cash cows. Cash Cows Businesses which enjoys a relatively high market share but low growth potential. They generate substantial profits & cash flows but their investment requirements are modest. The cash surpluses provided by them are available for use elsewhere in the business. Question Marks Businesses with high growth potential but low present market share. Additional resources are required to improve their market share & potentially convert them into stars. As there is no guarantee of this, that is why they are called Question Mark. Dogs Businesses with low market share & limited growth potential. Since the prospects for such products are bleak, it is advisable to phase them out rather than continue with them. As reflected above, it is apparent that cash cows generate funds and dogs, if divested, release funds. On the other hand, stars & question marks require further commitment of funds. Stoplight Matrix - Developed by General Electric Co. which focuses on Business Strength and Industry Attractiveness. Strong High Industry Attractiveness Medium Low Invest Invest Hold Business Strength Average Invest Hold Divest Weak Hold Divest Divest

As reflected above, businesses which are favorably placed justify substantial commitment of funds, businesses which are unfavorably placed call for divestment and businesses which are placed in between qualify for modest investment.
McKinsey Matrix This has 2 dimensions viz. Industry attractiveness &

Competitive position. The criteria or factors used for judging Industry attractiveness & Competitive position along with suggested weights are given below: Industry Attractiveness Competitive position. Criteria Weight Key Success Factors Weight ---------------------------------------------------------------------------------------------------Industry size 0.10 Market share 0.15 Industry growth 0.30 Technology 0.25 Industry profitability 0.20 Product quality 0.15 Capital intensity 0.05 After sales service 0.20 Technology stability 0.10 Price competitiveness 0.05 Competitive intensity 0.20 Low operating cost 0.10 Cyclicality 0.05 Productivity 0.10 Competitive position Good Medium High Industry Attractiveness Medium Low Winner Winner Profit Producer Winner Average Business Loser Poor Question Mark ____ Loser Loser -----

Strategic position & Action Evaluation (SPACE) : This approach is an extension of 2 dimensional portfolio analysis considering 4 dimensions
10

Companys competitive advantage. Companys financial strength Industry strength Environmental stability

The basic strategic postures associated with SPACE approach are :

1. Aggressive Posture means that the firm must fully exploit opportunities

available, seriously look for acquisition possibilities in its own or related industries, concentrate resources to maintain competitive edge & enhance market share. This is appropriate for a company which enjoys a competitive advantage & considerable financial strength and belongs to an attractive industry that operates in a relatively stable environment.
2. Competitive Posture Maintain & enhance competitive advantage by

product improvement, widening product line, improve marketing effectiveness and augment financial resources. This is suitable for a company which enjoys a competitive advantage but has limited considerable financial strength and belongs to an attractive industry operating in a relatively unstable environment.
3. Conservative Posture Prune non-performing products, reduce costs,

improve productivity, develop new products & access more profitable markets. This is appropriate for a company which enjoys financial strength but has limited competitive advantage & belongs to a not-so-attractive industry operating in a relatively stable environment.
4. Defensive

Posture Discontinue un-viable products, control costs aggressively, monitor cash-flows strictly, reduce capacity and postpone or limit investments. This is suitable for a company which lacks competitive advantage as well as financial strength and belongs to a not-so-attractive industry operating in an unstable environment.

Status Quo

Concentric Diversification
11

Conglomerate Diversification

Concentration

Diversification Divestment

Conservative

Vertical Integration Aggressive

COST LEADERSHIP

FOCUS

Defensive
GAMES MANSHIP

Competitive DIFFEREN TIATION

Concentric Merger Conglomer

Liquidation

Conglomerate Merger

Retrenchment [ Page-2.25 Chandra]

Turnaround

Diversification Debate: The dynamism of portfolio units bring success to the companies like Proctor & Gamble, Citigroup, Reliance, Sony, Unilever, etc. However, conglomerate diversification is considered to be a controversial investment strategy in-spite of the success of these companies. The advantage claimed for conglomerate diversification that it helps a company in reducing its overall risk exposure. In other words, Do not put all your in the same basket. Another benefit claimed for conglomerate diversification is that it expands opportunities for growth. If the opportunities in the existing business are limited because of some kind of saturation, it is natural to look at other businesses where growth opportunities exist. While the prospects of succeeding in the new line of business are often uncertain, it naturally tempt firms which have strong growth orientation. Some of the factors which appears to be responsible for the swing in favor of diversification are Desire to add 2nd and 3rd legs to overcome cyclical fluctuations.
12

 Argument of BCG group that no company was safe unless it had a portfolio consisting of at least 3 different kinds of businesses. Desire of many companies to gradually get out of existing industries & move into newer ones. Strategic Planning & Capital Budgeting: Capital budgeting must be intimately related to corporate strategy. Capital budgeting - multifunctional task linked to firms overall strategy. Generally companies strive for growth of revenues, assets & profits. The important growth strategies are concentration, vertical integration & diversification.

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

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

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

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

13

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

profit before interest & taxes / total assets which is influenced by following factors: 1. Demand variability Other things remaining equal, the higher the variability of demand for the products manufactured by the firm, the higher is the business risk. 2. Price variability A project having higher degree of volatility for the prices of its products is characterized by a higher degree of business risk. 3. Variability of Input prices When input prices are highly variable, business risk tends to be high. 4. Proportion of Fixed Operating costs - Other things being equal, if fixed cost represent a substantial portion of total costs, business risk is likely to be high. This is because when fixed costs are high, PBIT is more sensitive to variation in demand. Generally, the firm should be managed in such a way that the total risk borne by the equity shareholders consisting of business risk and financial risk is not unduly high. This implies that if the firm is exposed to high degree of business risk, its financial risk should be kept low & vice-versa.
o Norms of Lenders The norms enforced by the lenders have a bearing on

the capital structure viz. Financial institutions earlier permitted debt-equity ratio of 2 : 1. Now they allow debt-equity ratio 1 : 1. o Control Considerations After deciding by the promoters own share of investment, the extent of equity stake they want to have in a project has an important bearing on its capital structure. o Market Conditions If the equity market is buoyant & the equity shares can be issued at a premium, the project may rely more on equity & vice-versa. Reasons for Preferring use of Equity or Debt Equity Applicable tax rate is negligible Business risk exposure is high Dilution of control is not important Assets of the project are mostly intangible Project with many growth options. Debt Applicable tax rate is high Business risk exposure is low Dilution of control is as issue Assets of the project are mostly tangible Project with few growth options.

14

Menu of Financing -Finance for a project can be obtained from variety of sources. A firm can raise equity & debt capital from both public and private sources. Capital raised from public sources is in the form of securities offered to public through an offer document filed with SEBI. This can be traded on public secondary markets. Private capital may come from loans given by bank or financial institutions, etc. Besides other sources may be Internal accruals like depreciation charges & retained earnings, Working capital advance, etc. Equity Capital represents ownership capital as equity holders collectively hold the company. They enjoy the rewards & bear the risks of ownership. However their liability is limited to their capital contributions unlike the liability of the owner in a proprietary firm and the partners in a partnership concern. The terms followed are Authorised Capital : The amount of capital that a company can potentially issue as per its memorandum. Issued Capital : The amount offered by the company to the investors. Subscribed Capital : The part of the issued capital which is subscribed by the investors. Paid-up Capital : The actual amount paid-up by the investors. Typically Issued, Subscribed & Paid-up capital are same. Par value : The value stated in the memorandum & written in the share certificate. It is generally Rs. 10 /Issue Price : The price at which the equity share is issued. Generally issue price & par value are same. Book value : Paid-up equity capital + Reserves & surplus -- Intangibles No. of outstanding equity shares Market value : The price at which it is traded in the market. This price can be easily established for a company which is listed on the stock market & actively traded. Rights of Equity Shareholders : Right to Income the equity investors have a residual claim to the income of the firm after satisfying the claim of all other investors. The income of the equity shareholders may be retained by the firm or paid-out as dividends as per decision of the Board of Directors. Right to control Equity shareholders elect the Board of Directors & have the right to vote on every resolution placed before the company. Scattered & ill-organized, equity shareholders fail to exercise their collective power effectively. Often the indirect control is weak & ineffective because of indifference of most of the shareholders to attend annual general meeting and rarely bother to cast their votes by post or proxy.
15

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

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

Debentures

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

Working Capital Advance

- by commercial banks represents the most important source for financing current assets. It is provided by commercial banks as follows : Cash credits / Overdrafts A pre-determined limit for borrowing is specified by the bank based on requirements & financial strength of the company. Interest is charged on running balance & not on limit sanctioned. This form of advance is highly attractive as borrower can draw the amount in installments as & when required and repay as per availability of funds. Loans These are advances of fixed amount to the borrower. The borrower is charged interest on entire loan amount irrespective of the amount drawn. Loans are payable either on demand or in installments. Purchase / Discount of Bills The seller of goods draws the bill on purchaser. On acceptance of the bill by purchaser, the seller offers it to the bank for discount / purchase. When bank discounts / purchases the bill, it release the funds to the seller. The bank presents the bill to the purchaser on due date to receive the payment. Letter of Credit is an arrangement where a bank helps its customer to obtain credit from suppliers where the bank undertakes the responsibility to honour the obligation of its customers.
16

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

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

Raising Venture Capital A new company unable to tap public financial market
may seek venture capital. Such capital is provided by venture capital funds which finance untried company having promising prospects. It represents financial investment in a risky proposition in the hope of earning high rate of return.

Raising Capital in International Markets Due to globalization, Indian firms

can raise capital from international markets.

Financial Estimates & Projections : Cost of Project represent total outlay associated with a project supported by long term funds which broadly are as follows :
Land & site development Building & civil works Plant, machinery & other fixed assets
17

 Technical know-how & engineering fees Expenses on foreign experts & training of Indian employees abroad, if applicable Preliminary, capital issue and pre-operative expenses Contingency Margin money for working capital Initial cash losses

Means of Finance to meet the cost of project the following means of finance
are available. Share capital Term loans Debenture capital Deferred credit Incentive sources Miscellaneous sources

Estimates of Sales & Production Sales & Production may be estimated

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

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

Materials cost Utilities cost Labour cost Factory overheads

Working Capital Requirement & its Financing Working Capital There is always a time gap between sale of goods & receipt
of cash. Working capital is required for this period to sustain all the activities. In case adequate working capital is not available for this period company may not be in a position to purchase raw materials, pay wages & other expenses required for manufacturing the goods to be sold. This time gap is termed operating cycle of the business. The working capital requirement consists of the following: (a) Raw materials & components (indigenous as well as imported). (b) Stocks of goods-in-process or work-in-process. (c) Stocks of finished goods. (d) Debtors.
18

(e) Operating expenses. (f) Consumable stores. The principal sources of working capital finance are as follows: (1) Advances provided by commercial banks. (2) Trade credit. (3) Accruals & provisions. (4) Long-term source of financing. The working capital requirements should be met from both short-term as well as long-term sources of funds. The finance manager has to make use of both shortterm & long-term sources of funds in a way that the overall cost of working capital is the lowest and the funds are available on time & for the period needed. There are limits in obtaining working capital advances from commercial banks. They are decided by : (a) Lending norms followed by respective banks. (b) Against current asset a certain amount of margin money pr0ovided. Assessment of Working Capital Requirement: Different methods are available 1.By estimation of different constituents of working capital individually. 2. Percent of Sales Approach based on experience and past data. 3. Operating Cycle Approach begins with acquisition of raw materials & ends with collection of receivables. Duration of working capital or operating cycle O = R + W + F + D C where R = Raw material storage period = W = = F = = ______Average stock of raw materials_____ Average raw materials consumption per day Work in process period Average work-in progress inventory____ Average cost of production per day Finished stock storage period ___Average finished stock inventory___ Average cost of goods sold per day ____Average book debts____ Average credit sales per day

D = Debtors collection period =

C = Creditors payment period or Credit period allowed to debtors

19

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

Working Capital Management

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

Profitability Projections The profitability projections or estimates of working

results may be prepared along the following lines: A. Cost of production (Cost of materials, labour, utilities & overheads) B. Total administrative expenses (Remuneration to directors, communication & office materials, insurance, taxes, etc.) C. Total sales expenses (Packing, forwarding, sales promotion & advertising) D. Royalty & know-how payable E. Total cost of production (A+B+C+D) F. Expected sales G. Gross profit before interest (FE) H. Total financial expenses (Interest on loans, bank guarantee commission,etc.) I. Depreciation J. Operating profit (GHI) K. Other income L. Preliminary expenses written off M. Profit / loss before taxation (J + KL)
20

N. Provision for taxation O. Profit after tax (MN) Less dividend on : (1) Preference capital; (2) Equity capital P Retained profit Q Net cash accrual (P + I + L)

Computation of Ratios :
1.0 Profitability Ratios

1.1 Gross Profit Ratio 1.2 Net Profit Ratio 1.3 Return of Investment
2.0 Liquidity Ratio

= Gross Profit / Net Sales = Operating Profit / Net Sales = Profit before Tax / Capital Employed = Operating Profit / Capital Employed = Current Assets / Current Liabilities = Debt / Shareholders Fund

2.1 Current Ratio

3.0 Leverage Ratio

3.1 Debt Equity Ratio

4.0 Turn Over Ratio

4.1 Capital Turn Over Ratio = Net Sales / Capital Employed

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

Projected Balance Sheets The balance sheet shows the balance in various
asset & liability accounts reflecting the financial condition of the firm at a given point of time. Format of Balance Sheet prescribed by companies act Liabilities Assets Share capital Fixed assets Reserves & surplus Investments Secured loans Current assets, loans & advances Unsecured loans Misc. expenditures & losses Current liabilities & provisions The liabilities side of the balance sheet is the sources of finance employed by the business.
21

Share capital paid-up equity & preference capital. Reserves & surplus accumulated retained earnings shown in different accounts like capital reserve, investment allowance reserve & general reserve. Secured loans Borrowings of the firm against security like debentures, term loans from financial institutions & loans from commercial banks. Unsecured loans Borrowings of the firm without specific security like fixed deposit from public & unsecured loans from promoters. Current liabilities are obligations which mature in near future generally within a year. These obligations arise from items which enter the operating cycle like raw materials payment, accrual of wages, rentals, etc. Provisions include provision for tax, provident fund, pension & gratuity, proposed dividends, etc. The assets side of the balance sheet shows how funds have been used in the business. Fixed assets Tangible resources for producing goods & services. Shown as original cost less depreciation. Investments Financial securities owned by the firm. Current assets, loans & advances Cash, debtors, inventories of different kinds, loans & advances made by the firm. Miscellaneous expenditures & losses Outlays not covered in the described asset accounts & accumulated losses, if any. For preparing projected balance sheet at the end of year n+1, the following information are required: o The balance sheet at the end of year n o Projected income statement & distribution of earnings for year n+1 o Sources of external financing proposed to be tapped in year n+1 o Proposed repayment of debt capital during year n+1 o Outlays & disposal of fixed assets during year n+1 o Changes in level of assets during year n+1 o Cash balance at the end of year n+1

Multi- Year Projections Financial projections over a longer time frame.

22

UNIT II Market & Demand Analysis This should be carried out in a systematic & orderly manner. The steps of Project Analysis are as follows: Estimate the Potential size of the Market or Services Supply Demand Gap Patterns of Consumption Growth Income & Price Elasticity of Demand Composition of Market Nature of Competition Availability of Substitutes Reach of Distribution Channels

Situational Analysis & Specification of Objectives:

In order to get the feel of the relationship between the product and its market, the project analyst may informally talk to customers, competitors, middlemen & others associated in the industry. If such a situational analysis generates enough data to measure the market & get a reliable feedback over projected demand & revenues, a formal study may be dispensed with keeping time & cost considerations. However in most cases a formal study of the market & demand are warranted. An approach to spell out objectives is to structure the objectives in the form of questions. Key steps in market & demand analysis [ Refer Exhibit 4.1 of Book]

Collection of Secondary Information:

Secondary information has already been gathered in some other context & is already available. Primary information represents information that is collected for the first time to meet the specific purpose on hand. Thus secondary information provides the base & the starting point for the market and demand analysis. It provides leads for gathering primary information required for further analysis. There are a number of sources available for secondary information viz. Census of India, National Sample Survey Reports, Different Plan Reports, Economic Survey, Reserve Bank of India, Stock Exchange Directory, State Trading Corporation Reports

Conduct of Market Survey:

Secondary information needs to be supplemented with primary information gathered through market survey to keep a track on latest changes or developments.
23

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

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

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

24

Uncertainties in Demand Forecasting:

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

Market Planning: A marketing plan usually has following components

Current marketing situation dealing with different dimensions of the current

situation like Market situation, Competitive situation, Distribution situation, macro-environment, etc. Opportunity & issue analysis covering SWOT. Objectives have to be clear-cut, specific & achievable. Marketing strategy covers target segment, positioning, product line, price, distribution, sales force, sales promotion & advertising. Action plan is implementation of the strategy.

Technical Analysis Manufacturing Process / Technology: Out of different alternatives available, Choice of technology is influenced by a variety of considerations
Plant capacity Principal inputs Investment outlay & production costs Proven technology Product mix Latest developments Ease of absorption

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

proposed manufacturing process.

25

Material Inputs & Utilities: defining the materials & utilities required
specifying their properties and setting up their supply program. This may be classified in 4 broad categories Basic Raw Materials Processed Industrial Materials & Components Auxiliary Materials Utilities

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

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

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

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

Machineries & Equipment: requirement is dependent on production technology

& plant capacity. There may be different types like mechanical, electrical, instruments & controls, internal transportation system, etc.

Structures & Civil Works: cover site preparation & development, building &
structures and outdoor works.

Environmental Aspects: pollutants can be gaseous, liquid or solid in addition to

pollution arising out of noise, heat & vibration. Proper treatment & control facilities are to be arranged to avoid degradation of environment & health hazards.

Project Charts & Layouts: After finalizing the principal dimensions of the
project discussed project charts & layouts may be prepared to facilitate
26

implementation & operation like factory & plant layout, material flow diagram, process & instrument diagram, utility flow diagrams, etc.

Schedule of Project Implementation: Project implementation schedule is

prepared to facilitate systematic execution of the project within stipulated time & cost with the available resources. The following information are required for preparation of schedule : List of all possible activities from project planning to commencement of production. Sequence of performance of various activities. Time required to perform various activities. Resource requirement & allocation. Different tools & techniques like PERT & CPM are available for preparation of the project schedule.

Need for Considering Alternatives: There are alternative ways of transforming

an idea into a concrete project. These may differ in following ways: Nature of project may envisage manufacture of all parts & components in an integrated unit or consist of assembly type unit which obtains the parts & components from outside suppliers. The project may consists of processing up to the finished stage or may stop at semi-finished stage. Production process number of alternatives are available out of which the best suited considering resources, absorption capability, etc. Product quality & range shall depend on the market characteristics, consumer preferences, nature of competition, elasticity of demand, etc. Scale of operation shall depend on economics of scale, demand pattern, availability of resources, nature of competition, etc. Time phasing a given capacity can be installed in one stage or in phases suiting convenience. Location single or multi location choice shall depend on the trade off between economics of scale in manufacturing & logistics of distribution.

27

UNIT III Project Management

Forms of Project Organization:

The traditional form of organization is quite appropriate for handling established operations characterized by continuous flow of repetitive work with each department attending to specific work. However the traditional form of organization is not suitable for project management due to the reasons o Project is a non-repetitive, non-routine undertaking often associated with many uncertainties. o Relationships in a project setting are dynamic, temporary & flexible. o Project requires co-ordination of the effort of the persons drawn from different functional areas working under time & cost pressures. As such, there is a need for entrusting an individual (Project Manager or Coordinator) or group with the responsibility for integrating the activities of various departments & external agencies involved in the project work. The project organization may be of following forms depending on the authority given to the person responsible for project execution. Line & Staff Organization A project coordinator is appointed with the responsibility of coordinating the work of the people in the functional departments. He acts essentially in a staff position to facilitate coordination of line management. The project coordinator does not have authority & direct responsibility of line management. His influence would depend on his professional competence, closeness to top management & persuasive abilities. This form of organization is not suitable for large projects but may employed for small projects. Divisional Organization A separate division headed by the project Manager is set up to implement the project. The project manager has full line authority over these personnel. This type facilitates the process of planning & control, better integration of efforts & commitment of project related personnel. This form, however, may entail inefficient use of the resources of the firm due to duplication of efforts. Matrix Organization This seeks to achieve the twin objectives of efficient use of resources & effective realization of project goals. Here the personnel working on a project have responsibility to their functional superiors as well as to the project manager i.e. the authority is shared between the project manager & functional managers. Thus the project manager integrates the
28

contribution from various functional departments towards realization of project objectives. This is most popular form in execution of large projects.

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

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

Human Aspects of Project Management:

29

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

Pre-requisites for Successful Implementation:

Due to time & cost over-runs, projects tend to become uneconomical, resources are not available to support other projects & economical developments are adversely affected. The important areas to improve prospects of successful completion of projects are o Adequate formulation. o Sound project organization. o Proper implementation planning. o Timely availability of funds. o Judicious tendering & procurement. o Efficient contract management. o Effective monitoring & control. Network Technique Once the project is selected, the focus shifts on implementation. This involves completion of numerous activities by employing various resources men, machines, materials, money & time. Network - A network is constructed to represent a project graphically. It shows the position of various events & activities from start to finish. Network Techniques broadly comprises of PERT (Project Evaluation & Review Techniques) & CPM (Critical Path Method). These are essentially time oriented. Objectives of Network Techniques : Help in planning, scheduling & controlling projects. Creates & establishes relationship between different activities of the projects. Helps in reducing total time & cost of the projects. Complete the project within the stipulated period & cost. Optimum utilization of available resources. Avoid delays & interruptions, develops discipline & systematic approach. Steps : Breakdown of project activities. Estimating time requirement for each activity from similar projects or from experience.
30

 Establishing relationship between precedent, subsequent & concurrent activities. Construction of network diagram as per sequence. Network Logic : I. Event An event is the beginning or completion of a task. Thus event takes place at a particular instant of time & does not consume time or resources. Each event should have a distinct number. 1 2 II. Activity An activity is a definite task, job or function to be performed in a project represented by an arrow. As such activities occur between all events and link consecutive events in a network by an arrow. Activities consume time & resource. There will be only one activity between 2 events. Each activity must have a preceding & succeeding events. Not more than one activity can have same preceding & succeeding events. Predecessor Activity Activities that must be completed immediately prior to the start of another activity. Successor Activity - Activities that can not be started until one or more of the other activities are completed but immediately succeed them. Concurrent Activity - Activities that can be accomplished simultaneously. Dummy Activity - Activities that consume no time or resources.

O O O O
1. Slack is the freedom for scheduling or to start any event. An event for which slack is zero is critical event. 2. Float - This may be total, free or independent . Total Float signifies the maximum delay that can be permitted in the completion of activity without affecting project completion. Free Float is the time an activity can be rescheduled without affecting the commencement of succeeding activity.
31

Independent Float is the time by which an activity can be rescheduled without affecting both preceding & succeeding activities. Presence of float in a project signifies under utilization of resources and indicates inherent flexibility in the process. Features of Network : 1. In network diagrams arrows ( ) represent activities & circles ( O ) represent the events. Single activity can be represented once only in the network & events should not be repeated. 2. More than 1 activity can originate from an event or lead into an event.

3. Before an activity can be undertaken, all preceding activities must be completed. 4. Designed on the basis of logical, technical & interaction between different activities of the project. 5. The tail of the arrow represents the starting point of time of the activity & arrow head represents completion of time of the activity. 6. There should be no loops in the project network. Time Estimates : Generally 3 time values are obtained for each activity. Optimistic time (to) - shortest possible time to complete the activity if everything goes well i.e. without provision for any delay or setbacks. Most likely time (tm ) - is the best estimate of time which is likely to be accomplished. Pessimistic time (tp) - longest time to complete the activity under adverse conditions i.e. everything went wrong excluding force majeure situation. to + 4 tm + tp Expected activity time (te ) - is computed te = ---------------6 Earliest start time (EST) of an activity is the earliest finish time of preceding activity as network logic indicates that an activity cannot commence until the preceding event is completed. Earliest finish time (EFT) equals the earliest starting time plus duration of activity. Latest starting time (LST) is the latest finishing time minus activity duration.
32

Latest finish time (LFT) is the maximum time allowed to finish an activity. PERT NETWORK This is a diagram showing the steps needed to reach a stated objective. It depicts events, activities, interrelationship and recognizes progress to be made in one activity before subsequent activities can begin. Thus PERT network is a flow chart of independent events & activities each of which must be completed to achieve project objective. This is used with uncertain time estimates.

O----O----O----O
CRITICAL PATH METHOD The comparison of duration of different paths identifies a path whose duration is the longest. The path with longest duration of the project is called the critical path & the activities are known as critical activities. Critical activities have no float associated with them. If any activity on this path is delayed, then entire project is affected. The critical path helps to identify a set of activities & events which are critical and as such must be carefully monitored & controlled. The critical path is shown by thick or red or double line for clear differentiation. Characteristics Every network has a critical path. It is possible to have more than one critical path. Critical path connects first to last events. Earliest starting time is same as latest starting time Earliest finishing time is same as latest finishing time Crashing of a Project: Cost plays an important role in any project in addition to time management. Time cost relationship is of great significance in project management.
33

Crash time is the minimum possible time in which the activity can be completed and the cost associated with this time is the crash cost. The project costs consist of both direct & indirect costs. Direct costs can be linked directly with the activity viz. labor, material, equipment rental charges, etc. Generally increasing the direct activity cost e.g. working overtime by labor force can reduce the activity duration. Indirect costs are overhead costs, interest charges, loss of revenue / benefit due to late completion of the project, etc. An optimal project completion time will be the time for which sum of the direct & indirect costs are minimum. It can be observed that shortening the duration leads to increase in direct cost but decrease in indirect costs. The strategy will be justified only when there is net savings. Actual time-cost relationship could be of any shape but with the assumption of linearity for an individual activity, cost of crashing an activity by unit time is Crash Cost Normal Cost__ Normal Time Crash Time Procedure for Reducing Project Completion Time: 1. Identify all critical paths. 2. Compute for each activity on critical path, cost of reducing activity time by one unit Crash Cost Normal Cost__ Normal Time Crash Time 3. Consider the activity where the cost of crashing by unit time is minimum. However no activity can be reduced lower than the crash time. If there is at least one critical path on which none of the activities can be crashed then no further reduction of project completion time is possible. Network Cost System : The techniques of PERT & CPM overlooks the cost aspects which are equally important. To provide a vehicle for cost planning & control of projects, the network cost system was developed. The costs are planned, measured, analyzed & controlled in terms of project activities. Actual cost --- Value of work completed
34

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

Control of In-progress Projects

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

Post Completion Audits

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

Book Value of Assets Abandonment Analysis

Capital expenditure management is a dynamic process. With time changes may alter the attractiveness of the project leading to the decision to determine whether they should be continued or terminated or divested. A project may have to be abandoned due to its becoming non-viable. Such a situation may develop due to one or more of the following reasons : Change in Govt. policy Change in the demand pattern Obsolescence of the product An existing concern may also become non-viable at a certain stage & may become victim of industrial sickness. In such a situation, urgent steps are required for prevention of sickness & the case may have to be referred to BFIR. The board goes through the entire case of the company & recommends a suitable rehabilitation package or winding up as deemed fit.

Administrative Aspects of Capital Budgeting

This may be categorized as follows : Identification of promising investment opportunities. Classification of investment. Submission of proposals.
35

Decision making. Preparation of capital budget & appropriation. Implementation. Performance review.

Agency Problem
Managers as agents of shareholders are supposed to take actions that maximize the welfare of shareholders. In practice, managers enjoy substantial autonomy with a natural inclination to pursue their own goals. This is agency problem. The agency problem like empire building, excessive perquisites, etc. can be mitigated by monitoring the actions & behaviour of managers and by offering them right incentives that motivate to maximize value.

Evaluating the Capital Budgeting System of an Organization

The soundness of the capital budgeting system of an organization may be evaluated in terms of following criteria: Results : Are the results of the capital budgeting system consistent with the goals of the organization ? Techniques : Are efficient techniques being employed for purposes of capital expenditure planning, decision making & control ? Communication system : Whether proper communication system is adopted between the participants of the process ? Decentralization : Is there meaningful delegation & decentralization which permits decision making at appropriate level ? Adoptability : Are the policies, methods of analysis & procedures understood by different segment of the organization ? Flexibility : Does the system have sufficient flexibility to respond to the dynamic changes in the environment ? Control : Are adequate controls being exercised in the implementation phase to avoid slippage ? Review : Is there a systematic review which permits meaningful feedback for improving the effectiveness of the system ? Generation & Screening of Project Ideas: The search for promising project ideas is the first step towards establishing a successful venture. Identification of good business opportunities requires imagination, sensitivity to environmental changes & realistic assessment of the firms capability and resources capable to generate.

Generation of Ideas Broadly the following steps are useful:

SWOT analysis represents a conscious, deliberate & systematic effort by an organization to identify opportunities that can be profitably exploited.
36

 Identification of objectives towards (a) Cost reduction ; (b) Increase in capacity utilization ; (c) Improvement in quality & features ; (d) Diversification & Expansion into promising fields with imaginative thinking. Fostering a conductive climate in the enterprise to motivate the employees to think creatively & come forward with suggestions for improvement, diversification & efficiency.

Monitoring the Environment Any progressive firm should systematically

monitor the environment & assess its competitive abilities on the following areas: Economic sector generally covering (a) State of economy ; (b) Growth rate of primary, secondary & tertiary sectors and overall growth rate ; (c) Trade surplus / deficit ; (d) Balance of payment situation, etc. Government sector covering (a) Industrial policy ; (b) Govt. programs & projects ; (c) Tax framework ; (d) Subsidies, incentives & concessions available ; (e) Import & export policies ; (f) Financing norms & practices, etc. Technological sectors like (a) Innovation of new technologies ; (b) Access to foreign & indigenous know-how ; (c) Receptiveness & adoptability on the part of industry, etc. Socio-demographic sector including (a) Population trends ; (b) Income distribution ; (c) Educational profile, etc. Supply & infrastructure sector with respect to cost & availability of Raw materials, energy, transportation, etc.

Corporate Appraisal A realistic appraisals of corporate strengths &

weaknesses is essential for identifying investment opportunities which can be profitably exploited. The following aspects are emphasized (a) Marketing & distribution ; (b) Production & operations ; (c) Research & development ; (d) Corporate resources & personnel ; (e) Finance & accounting, etc.

Profit Potential of Industries Several tools or frameworks are available like

o Porter model emphasized that profit potential of an industry depends on the combined strength of following 5 competitive forces (a) Threat of new entrants ; (b) Rivalry amongst existing firms ; (c) Pressure from substitute products ; (d) Bargaining power of buyers & (e) Bargaining power of sellers
o o

Life cycle approach which include following stages (a)Pioneering; (b) Rapid growth ; (c) maturity & stabilization and (d) Decline. Experience curve is a useful tool for planning investments aimed at reducing costs towards long-term survival & profitability of the
37

firm. It stressed on the areas of (a) learning curves ; (b) Technological advances ; (c) Economics of scale, etc. Scouting for Project Ideas Wide variety of sources should be tapped to
identify good project ideas like : Analyze the performance of existing industries. Examine the inputs & outputs of various industries. Review imports & exports. Study plan outlays & Govt. guidelines. Scrutinize the suggestions of financial institutions & developmental agencies. Investigate local materials & resources. Analyze economic & social trends. Check new technological developments, etc..

Preliminary Screening This is required to eliminate ideas which prima-facie

are not promising from the list of number of possible projects suggested. The aspects may be checked for this purpose. Compatibility with the promoter. Consistency with govt. priorities. Availability of inputs. Adequacy of market. Reasonableness of cost Acceptability of risk level. Project Rating Index 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. The steps involved are : Identify factors relevant for project rating. Assign weights to reflect the relative importance of these factors. Rate the project proposal on various factors, using a suitable rating scale. For each factor, multiply the factor rating with factor weight to get the factor score. Add all the factor scores to get the overall project rating index.

Sources of Positive NPV Broadly there are 6 main entry barriers that result in
positive NPV projects : Economics of scale. Product differentiation. Cost advantage.
38

 Marketing reach. Technological edge. Government policy.

On being an Entrepreneur The qualities & traits of a successful entrepreneurs

should cover o Willingness to make sacrifices. o Leadership. o Decisiveness. o Confidence in the project. o Marketing orientation. o Good human relations. o Flexibility.

Every prospective entrepreneur must analyze in the following aspects 1.0 Are goals well defined with respect to (a) personal aspirations ; (b) business susceptibility & size ; (c) tolerance for risk. 2.0 Checking right strategy covering (a) clear definition ; (b) profitability & potential for growth ; (c) durability ; (d) rate of growth. 3.0 Capability to execute the strategy involving (a) resources ; (b) organizational infrastructure ; (c) promoters role.

39

UNIT IV
Risk Analysis Firm Risk & Market Risk:

40