P. 1
Project Mgt

Project Mgt

|Views: 648|Likes:
Published by gaurisj_55

More info:

Published by: gaurisj_55 on Jan 31, 2011
Copyright:Attribution Non-commercial

Availability:

Read on Scribd mobile: iPhone, iPad and Android.
download as PPT, PDF, TXT or read online from Scribd
See more
See less

06/22/2013

pdf

text

original

01/01/2010 1

PROJECT MANAGEMENT
MMS, PGDM (Ops.) (2009-11)
- Semester IV.
The things which I always want you to
act on……but which you don‟t:
• Read the portions in advance;
• Do not miss any class;
• Be attentive in the class;
• Seek clarifications when required;
• Read the topics dealt with in the class on the
same day or discuss with your friends to
enhance your understanding of the topic;
• Quickly revise all the covered portions at least
once in a week.
• If you do all the above, „My Good Wishes are
Always with All of You‟ will definitely work.
01/01/2010 2
01/01/2010 3
Index to Topics:

No Name of Topic Slide
Nos.:
1. Introduction, Scope and coverage 11 - 62
2. Project Function in an organisation,
Layout of Project Department, Role of
Consultants in Project Management

63 -107
3. Project Identification – Selection of
product, identification of market,
preparation of feasibility study/report

110 -
147
4. Project formulation, Evaluation of risks,
preparation of project report.
148 –
183
01/01/2010 4
5 Selection of location and site of the project,
Factors affecting location
184 –
219
6 Policies of Central and State Governments
towards location, Legal aspects of Project
management

220 –
334
7 Financial analysis-Profitability Analysis, Social
Cost Benefit Analysis
335 –
423
8 Budget and Cash Flows 424 -
9 Materials Management in Project Planning-
Procurement, storage and disposal
10 Financing of the project –Sources of Finance,
Cost implications thereof
01/01/2010 5
1
1
Financial Institutions- Guidelines for funding
projects, Risk Analysis – Sensitivity Analysis
1
2
Quantitative aspects of projects – PERT/CPM,
Network analysis for monitoring of the project
1
3
Computer applications – Selection of software
packages for application to Project Management
Reference Books
1. SC : Project Management – By S.Chaudhury;
2. PG : Text Book of Project Management –
By P.Gopalakrishnan and V E Ramamoorthy;
3. PC: Project Management – By Prasanna
Chandra (SeventhEdition, 2009/Sixth Edition);
(Tata McGraw –Hill Publishing Co. Ltd)
• 4. PM: Project Appraisal – By P K Mattoo;
• 5. VD : Project Management – By Vasant Desai
(3
rd
revised Edition, 2008)- (Himalaya Publishing
House);
01/01/2010 6
Reference Books…
• 6. IC: Project Management by ICFAI Centre
for Management Research;
• 7. ICFAI : Finance Series- Project Management:
Vol. I to V by ICFAI;
• 8.Project Management – The Managerial
Process : By Clifford F. Gray and Eric W.
Larson-3
rd
Edition –Tata McGraw Hill Education
Pvt. Ltd.
01/01/2010 7
Useful Websites
• http://www.dipp.nic.in (Dept. Of Industrial Policy and
Promotion, Govt. of India);
• http://www.india.gov.in (Government of India);
• http://www.rbi.org.in (Reserve Bank of India;
• www.ifciltd.com (Industrial Finance Corporation of India
Ltd.);
• http://www.weforum.org (World Economic Forum,
Geneva, Switzerland
• (www.icicibank.com (ICICI Bank Ltd.);
• www.idbi.com (IDBI Bank Ltd.);
• www.utimf.com (UTI Mutual Funds);
• www.utiventures.com (UTI Ventures Ltd.);
01/01/2010 8
Useful Websites....
• www.licindia.com (Life Insurance Corporation of India);
• www.nsic.co.in (National Small Industries Corporation
Ltd.)
• www.sidbi.com (Small Industries Development Bank of
India Ltd.);
• http://www.idfcpe.com/pages/main1.html and
http://www.idfc.com ) (Infrastructure Development
Finance Co. Ltd.-IDFC);
• www.eximbankindia.com (Export-Import Bank of India);
01/01/2010 9
Useful Websites....
• www.nabard.org (National Agricultural Bank for Rural
Development-NABARD);
• http://www.worldbank.org/ (World Bank):
• http://www.microsoft.com/project/en/us/product-
information.aspx (Microsoft Office Project Professional –
Project Soft ware)
---------------------------------------------------------------------------
Total Marks: 100 (Internal Assessment: 40 marks +
Final Written Examination : 60 marks)
(Internal Assessment :  Attendance : 10 marks +
 Presentations - Assignments of Teaching of
topics to the class : 15 marks +  Class Test : 15
marks. )
01/01/2010 10
01/01/2010 11
1. Introduction: Project and
Project Management
• ―Project Management is the business process of
creating a unique product, service or result. A
project is a finite endeavour having specific
start and completion dates undertaken to
create a quantifiable deliverable. Projects
undergo progressive elaboration by developing
in steps and predictable increments that are tied
to benchmarks, milestones and completion
dates.‖
• A Project is a specific activity on which money is
spent in the expectation of returns. There is
therefore a specific starting point, a specific end
point and it is intended to achieve a specific
objective.
01/01/2010 12
1.Introduction: Project and
Project Management
• Project is an organised programme of activity
carried out to reach a defined goal, often of a
non-recurring nature with a specified terminal
point.
• It is a package of time-bound, scheduled and
assembled activities dedicated to the attainment
of a specific objective of successful completion
of a work on time and within the allotted
budget.
• Project is a one-shot, time-tested, goal-
directed major undertaking requiring the
commitment of varied skills and resources.
01/01/2010 13
1.Introduction: Project and
Project Management
• Project is the whole complex of activities
involved in using resources to gain benefits.
• Project is a system involving coordination of a
number of interrelated activities to achieve a
specific objective.
• Project Management Institute (PMI) : ―A Project
is a temporary endeavour undertaken to create
a unique product or service.‖ ―Project
Management is the application of knowledge ,
skills, tools and techniques to project activities in
order to meet or exceed stakeholder needs and
expectations.‖
01/01/2010 14
1.Introduction: Project and
Project Management

• The British Standard (1996) : “Project is a
unique set of coordinated activities, with
definite starting and finishing points,
undertaken by an individual or organisation
to meet specific objectives within defined
schedule, cost and performance
parameters.”
• Some examples of ‗projects‘ are: relocating a
factory, constructing national highways,
organising the Olympics and constructing a
hydro power generating facility.
What is not a project?
• Emergency response to operations problems
– Callouts
– Repairs and troubleshooting

• Routine operations support
– Maintenance of equipment
– Minor modifications and tuning of equipment
01/01/2010 16
1.Introduction: Project and
Project Management

• This finite characteristic of projects stands in
sharp contrast to processes, or operations,
which are permanent or semi-permanent
functional work to repetitively produce the
same product or service.
• In practice, the management of these two
systems is often found to be quite different,
and as such requires the development of
distinct technical skills and the adoption of a
separate management philosophy.


01/01/2010 17
1.Introduction: Project and
Project Management
• Project Management (PM) is quite unique. It
calls for sharper tools of planning and control
and improved ways of coping with human
problems caused in a project setting.
• PM is complex. It involves issues like forms of
project organisation, project planning,
project control and human aspects of PM.
• PM is always customer specific, the
requirements and constraints within which a
project must be executed are stipulated by the
customer.
01/01/2010 18
1.Introduction: Project and
Project Management
• PM is always interdependent and inter-related.
The management should be quick and flexible in
dealing with ever-changing dynamic situations
which pervade very many aspects of the society.
• In sum, PM is a teamwork. It will organise
around a process that is essentially customer-
oriented. It will always strive to bring maximum
benefit to the society with minimum cost within
the shortest stipulated time frame.
01/01/2010 19
1.Introduction: Project and
Project Management
• Generally, Organisational structures and
processes are custom made to produce a
specific product or service. Sometimes,
organisations have to take up new tasks that
they are not equipped to handle.
• These tasks are new to the organisation as
they are not performed earlier or they may
not be repeated in the future.
• To perform such unique tasks, organisations
adopt the project approach. The project
approach is adopted when the existing
systems in the parent organisation are not
equipped to handle the new task.
01/01/2010 20
1.Introduction: Project and
Project Management
• Some of the characteristics of the tasks that
qualify to be projects are:
×Unique activities;
×Attainment of a specific goal;
×Sequence of activities;
×Specified time;
×Interrelated activities.
Project Management
- Knowledge Areas:
• Scope Management
• Time Management
• Cost Management
• Quality Management
• Human Resources Management (Organizational
Planning; Staff Acquisition; Team Development )
01/01/2010 21
Knowledge Areas….
• Communications Management
(Communications Planning; Information
Distribution; Performance Reporting;
Administrative Closure )
• Risk Management (Risk Identification;
Risk Quantification; Risk Response
Development; Risk Response Control)
01/01/2010 22
Knowledge Areas….
• Procurement Management (Procurement
Planning; Solicitation Planning;
Solicitation; Source Selection; Contract
Administration; Contract Close-out)
• Integration Management ( Project Plan
Development; Project Plan Execution
Overall Change Control )


01/01/2010 23
Leadership Skills:
• Vision and Strategy
• Establishing Direction
• Aligning People
• Communicating
• Negotiating
• Motivating and Inspiring
• Influencing Organizations
• Overcoming Barriers to Change
01/01/2010 24
General Management Skills:
• Planning
• Finance and Accounting
• Personnel Administration
• Technology
• Organizational Development
• Delegation
• Team Building
• Conflict Management
• Solving Problems
01/01/2010 25
Communications Skills:
• Writing
• Listening
• Speaking
• Presenting
• Media Relations
• Meeting Management
01/01/2010 26
Project Management

• The success of a project depends on the project
manager‘s ability to strike a balance between
these interrelated variables or constraints.
Some of the common constraints that influence
the project are:
Scope;  Quality;  Cost;  Time;
Resources.
01/01/2010 27
01/01/2010 28
1.Introduction: Scope and coverage
• „Scope‟ of a project:
• A project management term for the combined
objectives and requirements necessary to
complete a project.
• Properly defining the scope of a project allows a
manager to estimate costs and the time required
to finish the project.
• Scope can involve a variety of things, depending
on the type of project. For example, if the project
was to design an airplane, the scope could
include the functional requirements of the plane,
such as how many passengers it can carry or
how fast it should be able to travel.
1.Introduction: Scope and coverage
• It is the responsibility of the project manager to
ensure that the scope's deadlines are met,
allowing for smooth completion of the project.
• This may be sidetracked by scope creep, which
occurs when the project gains additional
features or requirements without extending the
deadline.
1.Introduction: Scope and coverage
• The Scope of a project can be divided into two
parts: „Product Scope‟ and „Project Scope‟.
• The Product Scope details all the functions and
features that are to be included in a product or
service of a product whereas the Project Scope
details the work to be done to deliver a required
product with specific features.
• The tools and techniques for managing product
scope vary with the nature of the project.
Scope Management:
• Initiation
• Scope Planning
• Scope Definition
• Scope Verification
• Scope Change Control
01/01/2010 31
Scope Management:
• Project Planning : Components:
What ? : Work Breakdown Structure;
 How? : Plans and Specifications;
 Who? : Organisation Breakdown Structure;
 How Much?: Cost Breakdown Structure (Via
Estimates);
 When? : Schedule.
01/01/2010 33
1.Introduction: Scope and coverage
• In PM, the scope of a project is the sum total of
all of its products and their requirements or
features. Sometimes the term scope is used to
mean the totality of work needed to complete a
project.
• Scope is a brief and accurate description of the
end-products or deliverables to be expected
from the project that meet the requirements.
• Scope describes all the activities that are to be
performed, resources that will be consumed and
the end-products from the successful completion
of the project, including quality standards.
01/01/2010 34
1.Introduction: Scope Statement
• The scope also includes the target outcomes,
prospective customers, outputs, work, financial
and human resources required to complete the
project.
• Scope Planning/Statement: Scope Planning
involves the development of the Scope
Statement.
• The Project Manager uses tools like product
analysis, cost/benefit analysis, and expert
judgment to develop the scope of a project.

01/01/2010 35
1.Introduction: Scope Statement

• In traditional PM, the tools to describe a project's
scope (product) are the product breakdown
structure and product descriptions.
• The primary tool to describe a project's scope
(work) is the work breakdown structure.
• Scope statements may take many forms
depending on the type of project being
implemented and the nature of the organization.
01/01/2010 36
1.Introduction: Scope Statement
• The scope statement details the project
deliverables and describes the major
objectives. The objectives should include
measurable success criteria for the project.
• ‗Deliverables‘ is a Project Management term for
the quantifiable goods or services that will be
provided upon the completion of a project.
• Deliverables can be tangible or intangible parts
of the development process, and are often
specified functions or characteristics of the
project.
1.Introduction: Scope Statement
• As a baseline, scope statements should contain:
×The project name
×The project charter
(A project charter or project definition --
sometimes called the terms of reference-- is a
statement of the scope, objectives and
participants in a project. It provides a
preliminary delineation of roles and
responsibilities,……
01/01/2010 38
1.Introduction: Scope Statement
….outlines the project objectives, identifies the
main stakeholders, and defines the authority
of the project manager. It serves as a
reference of authority for the future of the
project.)
×The project owner, sponsors, and
stakeholders
× The problem statement
× The project goals and objectives

01/01/2010 39
1.Introduction: Scope Statement-
Product Breakdown Structure (PBS)
×The project requirements
×The project deliverables
×The project non-goals (what is out of scope)
×Milestones
×Cost estimates
• In PM, a product breakdown structure (PBS) is
an exhaustive, hierarchical tree structure of
components that make up an item, arranged in
whole-part relationship.
• A PBS can help clarify what is to be delivered by
the project and can help build a Work
Breakdown Structure (WBS).
01/01/2010 40
1.Introduction: Scope Statement-PBS
• The PRINCE2 project management method
mandates the use of product based planning,
part of which is developing a product breakdown
structure.
• PRojects IN Controlled Environments (PRINCE)
is a project management method. It covers the
management, control and organisation of a
project. "PRINCE2" refers to the second major
version of this method and is a registered
trademark of the Office of Government
Commerce (OGC), an independent office of HM
Treasury of the United Kingdom.

PRINCE2
• PRINCE2 is a structured approach to project
management.
• It provides a method for managing projects within a
clearly defined framework.
• PRINCE2 describes procedures to coordinate
people and activities in a project, how to design and
supervise the project, and what to do if the project
has to be adjusted if it doesn‘t develop as planned.
• In the method each process is specified with its key
inputs and outputs and with specific goals and
activities to be carried out, which gives an automatic
control of any deviations from the plan.
01/01/2010 42
Figure of a PRINCE2 process model
01/01/2010 43
1.Introduction: Scope Statement-PBS
• Example : PBS of a computer:
+Main unit : -Housing; --Motherboard : CPU,
• RAM chips, ... ; -- FDD, --HDD, --Video
card,--Sound card, --Network card, --LPT
port card.
+Monitor : --CRT, --Housing, --Electronic
components
01/01/2010 44
1.Introduction: Scope Statement-
Work Breakdown Structure (WBS)
+Mouse : --Body, --Marble, --Cable…..
+Keyboard
• A WBS in project management and systems
engineering, is a tool that defines a project and
groups the project‘s discrete work elements in a
way that helps organize and define the total
work scope of the project.
01/01/2010 45
1.Introduction: Scope Statement-WBS
• A WBS element may be a product, data, a
service, or any combination. WBS also provides
the necessary framework for detailed cost
estimating and control along with providing
guidance for schedule development and control.
• Additionally the WBS is a dynamic tool and can
be revised and updated as needed by the
project manager.
• The WBS is a tree structure, which shows a
subdivision of effort required to achieve an
objective; for example a program, project, and
contract.
01/01/2010 46
1.Introduction: Scope Statement-WBS
• The WBS may show hardware, product, service,
or may be process oriented. In a project of
contract, the WBS is developed by starting with :
– the end objective and
– successively subdividing it into manageable
components
– in terms of size, duration, and responsibility
(e.g., systems, subsystems, components, tasks,
subtasks, and work packages)
– which include all steps necessary to achieve the
objective.
01/01/2010 47
1.Introduction: Scope Statement-WBS
• The WBS provides a common framework for
the natural development of the overall planning
and control of a contract and is the basis for
dividing work into definable increments from
which the statement of work can be developed
and technical, schedule, cost, and labour hour
reporting can be established.
• A WBS permits summing of subordinate costs
for tasks, materials, etc., into their successively
higher level ―parent‖ tasks, materials, etc.
01/01/2010 48
1.Introduction: Scope Statement-WBS
• For each element of the WBS, a description of
the task to be performed is generated.
• This technique (sometimes called a System
Breakdown Structure) is used to define and
organize the total scope of a project.
• A WBS is not an exhaustive list of work. It is
instead a comprehensive classification of project
scope.
• A WBS is not a project plan or a project
schedule and it is not a chronological listing.
01/01/2010 49
1.Introduction: Scope Statement-WBS
• It is considered poor practice to construct a
project schedule (e.g. using project
management software) before designing a
proper WBS.
• This would be similar to scheduling the activities
of home construction before completing the
house design.
• Without concentrating on planned outcomes, it is
very difficult to follow the 100% Rule at all levels
of the WBS hierarchy. (See the 100% rule
elaborated in the notes).
01/01/2010 50
1.Introduction: Scope Statement-WBS
• If the WBS designer attempts to capture any
action-oriented details in the WBS, he/she will
likely include either too many actions or too few
actions.
• Too many actions will exceed 100% of the
parent's scope and too few will fall short of 100%
of the parent's scope.
• The best way to adhere to the 100% Rule is to
define WBS elements in terms of outcomes or
results.
• This also ensures that the WBS is not overly
prescriptive of methods.
01/01/2010 51
1.Introduction: Scope Statement-WBS
• Mutually exclusive elements : In addition to the
100% Rule, it is important that there is no
overlap in scope definition between two
elements of a WBS.
• This ambiguity could result in duplicated work or
miscommunications about responsibility and
authority.
• Likewise, such overlap is likely to cause
confusion regarding project cost accounting.
• A WBS is not an organizational hierarchy.

01/01/2010 52
1.Introduction: Scope Statement-WBS
• Some practitioners make the mistake of creating
a WBS that shadows the organizational chart.
• While it is common for responsibility to be
assigned to organizational elements, a WBS that
shadows the organizational structure is not
descriptive of the project scope and is not
outcome-oriented.
• WBS updates, other than progressive
elaboration of details, require formal change
control. This is another reason why a WBS
should be outcome-oriented and not be
prescriptive of methods.
01/01/2010 53
1.Introduction: Scope Management Plan
• Methods can, and do change frequently, but
changes in planned outcomes require a higher
degree of formality.
• If outcomes and actions are blended, change
control may be too rigid for actions and too
informal for outcomes.
• A WBS is not a logic model. Nor is it a strategy
map.
• Scope Management Plan is one of the major
Scope communication documents.
01/01/2010 54
1.Introduction: Scope Management Plan
• The Project Scope Management Plan
documents how the project scope will be
defined, managed, controlled, verified and
communicated to the project team and
stakeholders/customers.
• It also includes all work required to complete the
project.
• The documents are used to control what is in
and out of the scope of the project.
• The Project Scope Management plan is included
in as one of the sections in the overall Project
Management plan.
01/01/2010 55
1.Introduction: Scope Management Plan
• It can be very detailed and formal or loosely framed
and informal, depending on the communication
needs of the project.
• Product Analysis is a technique for understanding
the features and functions of a product.
• Techniques like ‗Value Analysis‘ and ‗Quality
Function Deployment‘ help the Project Manager gain
more information regarding the project.
• By enhancing the level of his knowledge of the
project‘s product, the project manager can define
the scope of the project more precisely.
{Value engineering (VE) is a systematic method to
improve the "value" of goods and services by using
an examination of function. ……..
01/01/2010 56
1.Introduction: Scope Management Plan
…….Value engineering is also referred to as
"value management" or "value methodology"
(VM), and "value analysis" (VA)}
{Quality function deployment (QFD) is a ―method
to transform user demands into design quality, to
deploy the functions forming quality, and to
deploy methods for achieving the design quality
into subsystems and component parts, and
ultimately to specific elements of the
manufacturing process.‖- as described by Dr. Yoji
Akao, who originally developed QFD in Japan in
1966, when the author combined his work in quality
assurance and quality control points with function
deployment used in Value Engineering.}
01/01/2010 57
1.Introduction: Project phases
• QFD is designed to help planners focus on
characteristics of a new or existing product or
service from the viewpoints of market segments,
company, or technology-development needs. The
technique yields graphs and matrices.
• QFD helps transform customer needs (the voice of
the customer [VOC]) into engineering characteristics
(and appropriate test methods) for a product or
service, prioritizing each product or service
characteristic while simultaneously setting
development targets for product or service. (See
more in notes from Wikipedia)
01/01/2010 58
Project phases
• PM can be divided into six phases:
• Initiation phase, 2.Definition phase, 3.Design
phase, 4.Development phase, 5.Implementation
phase and 6.Follow-up phase.
• You may also look at the project activities as
Pre-project and post-project and break them
into several stages for a clear understanding of
the tasks involved in a project.

01/01/2010 59
1.Introduction: Project phases
• Pre-project activities may be generally broken
down as:
¬ Conceptualising ¬Market Survey, feasibility
study and expansion plans giving final picture
¬Focussing with respect to quality, capacity or
product mix with capacities ¬ Site selection,
taking into consideration availability of raw
materials, infrastructural facilities, finished
goods, market location or area targeted, and a
balance amongst these ¬ Basic engineering
and extended basic engineering considering
local condition…..
01/01/2010 60
1.Introduction: Project phases
…..¬Detailed engineering and statutory
documentation preparation for required
approvals from various bodies, safety and
security ¬Procurement, transportation and
insurance etc. ¬erection and pre-
commissioning activities ¬ Commissioning
¬Performance trials and commercial
production.
• The Post-project activities may be similarly
broken down into the following activities:
• ¬Stabilising the process parameters and
instrument settings…..
01/01/2010 61
1.Introduction: Project phases
….¬Preparation of ‗as–built‘ drawings,
incorporating all the changes/ modifications
made during execution, commissioning and
stabilising operations including field changes,
and all the operating disciplines ¬ Training of
operation, maintenance and safety staff ¬
Compilation of all operating and maintenance
manuals, catalogues, drawings and technical
details, in an easily retrievable manner including
guarantees for equipments ¬ Awareness
programmes for quality and safety ¬ Monitoring
balance erection work such as roads, drains,
plastering, paintings etc.,….
01/01/2010 62
1.Introduction: Project phases
….¬ Finalising contractors‘ bills and sorting out
disputes with suppliers and contractors ¬ Site-
cleaning and housekeeping ¬ Storage of spares
with proper inventory and security.
01/01/2010 63
2. Organising Project Dept.
· Organisational planning of Project Dept.:
× An organisation can be defined as a group of
individuals who coordinate their activities in
order to accomplish a business and /or social
objective.
×Organisational planning is a process of
identifying, documenting, and assigning
project roles, responsibilities, and reporting
relationships.
×Choosing an appropriate organisational
structure facilitates the effective implementation
of an organisational plan.
01/01/2010 64
2. Organising Project Dept.

• The individuals or groups who may be a part of
the organisation or may be external to it.
• The structure of an organisation is dependent on
parameters like the rate of change of
technology, availability of resources, the
product/services sold, competition and other
decision making requirements.
• Developing an organisational structure also
helps in delegating tasks with responsibility and
accountability.
01/01/2010 65
2. Organising Project Dept.
• A project manager‘s choice of organisational
structure depends on the nature of the project and
the degree of control required for its
implementation.
• Some of the organisational structures that a
project manager can consider are:
× Traditional Organisational Structure × Pure
PRODUCT Organisational Structure × Pure
PROJECT Organisational Structure × Matrix
Organisational Structure.
01/01/2010 66
2. Organising Project Dept.
• The Traditional Organisational Structure is
developed around the functional aspects of the
organisation such as engineering, manufacturing,
marketing, human resource and information
systems.
• While Projects in individual functional
departments do not face any problems, when
different departments have to be coordinated,
the project manager may have to assign, control
and monitor the work through the functional
manager, because of his lack of authority in the
functional department.
01/01/2010 67
2. Organising Project Dept.
• Some of the advantages and disadvantages of
the Traditional structure are as follows
Advantages Disadvantages
Easy
control,
budgeting
procedures
No single person is responsible
for the total project – lack of
authority and hence reduced
motivation and innovation
01/01/2010 68
Sharing of
knowledge and
responsibility
and grouping
of specialists
Project-oriented emphasis is absent
and hence lacks customer focus and
slow in responding to customers‘
needs, ideas are function oriented and
not project-oriented—difficulty in
achieving tasks
Flexibility in
use of broad
manpower
Complex coordinating system—
consumes more time in approving the
decisions
Continuity in
functional
disciplines
Possibility of partiality in decision
making
01/01/2010 69
Reporting structure with
good control over
people
Lack of proper project-
oriented planning and
authority-leads to difficulty
in pinpointing
responsibilities.
Quick reactions to
situations depending
upon the functional
manager‘s priority.

2. Organising Project Dept.

01/01/2010 70
2. Organising Project Dept.
• Pure Product Organisational Structure is
developed on the basis of managing individual
products as functional departments. Each
individual product is assigned a product
manager who has functional specialists to
assist him.
• The basic advantage of this structure is the
individual line of authority, i.e. a single individual
has the authority to control the entire activity.
• Its narrow reporting structure helps develop a
strong communication channel along with
accelerated feedback.
01/01/2010 71
Advantages Disadvantages
Enables strong
control because of
single project
authority
Duplication of efforts, facilities
and personnel – leading to
prohibitive costs of
maintenance in multi-product
organisations
Direct link between
the project manager
and other
stakeholders
Retains personnel in projects
longer than necessary
2. Organising Project Dept.
01/01/2010 72
Develops strong
communication
channels
Firm‟s progress is hindered
by the lack of strong
functional groups and
technology
Maintains project
expertise without
sharing key
personnel
Controlling functional
specialists requires top level
coordination
Facilitates speedy
reactions to
situations
Technology is not shared
among projects
01/01/2010 73
Facilitates loyalty of team
members towards project
No career
prospects for the
project team
Retains attention on
customer relations
Enhances decision making
efficiency of senior
management
2. Organising Project Dept.
01/01/2010 74
2. Organising Project Dept.
• Pure Project Organisational Structure:
Organisations working on large and long-term
projects usually adopt pure project organisational
structure.
• This type of organisation structure contains
functional departments within the individual
projects.
• All the team members contribute on full time
basis.
• This is a vertical organisational structure which
avoids conflicts and problems faced by the
traditional and product organisational structures.
01/01/2010 75
Advantages Disadvantages
The Project Manager has complete
authority over the project
Inefficiency in resource
utilisation
The Project Manager has the
freedom to acquire the resources
needed for the project‘s progress
Duplication of facilities
The Project team reports directly to
the Project Manager – thus
develops a formal communication
channel between the Project
Manager and his team
Sourcing personnel
from internal functional
departments to work on
the project affects work
in the functional
departments
01/01/2010 76
2. Organising Project Dept.
The Project personnel are shared
between the project and the
project organisation
Facilitates unity of command
01/01/2010 77
2. Organising Project Dept.

• ×The Matrix Organisational Structure: A Matrix
organisational structure is formed as a result of
combining the advantages of all the
aforementioned organisational structures.
• It is suitable for project driven organisations like
software development firms.
• It makes the Project Manager totally responsible
and accountable for the success for a project.
• Every project is treated as profit centre. Hence
the GM directly assigns power and authority to
the Project Manager to handle the project……
01/01/2010 78
2. Organising Project Dept.
• …….The Project Manager is responsible for the
technical excellence of the functional
departments in managing the departments.
• This structure functions in a collaborative
manner – i.e. it shares the information and
personnel while executing the project.
• The primary objective of the Matrix
organisational structure is to derive synergy
through shared responsibility between the
project and functional management.
• The strength of the structure depends on the
level of control that the Project Manager is able
to exercise over the functional resources.
01/01/2010 79
2. Organising Project Dept.
• Advantages of the Matrix organisational
structure:
¬Enables the Project Manager to exercise control
over all the resources
¬ Every project has its own independent set of
policies and procedures
¬ Authorises the Project Manager to commit the
company resources ensuring that scheduling
does not clash with other projects
¬ Facilitates quick response to conflicts, changes
and other project needs
01/01/2010 80
2. Organising Project Dept.
¬Derives support of the functional department to
the project
¬Enables proper HR Development by enhancing
the career prospects of team members
¬ Facilitates cost minimisation by sharing key
personnel
¬Facilitates spending more time to solve complex
problems
¬ Develops a strong technical base
¬ Eases solving of the problems that require top
management involvement
01/01/2010 81
2. Organising Project Dept.
¬Minimises conflicts
¬ Ensures optimum balance among time cost and
performance
¬Enables authority and responsibility sharing
• There are some pre-conditions to be fulfilled for
a Matrix Organisation Structure to be
established. They are: It should be ensured
that :
+All the team members commit to spend full time
on the project
+Conflicts are resolved quickly…….
01/01/2010 82
2. Organising Project Dept.
+The resources are negotiated with function and
project oriented managers
+The functional departments function as
individual entities
• It is observed that the following are the situations
which favour the implementation of the Matrix
structure:
The primary output of an organisation is a
complex product
The organisation serves multiple customers in
different geographical locations
01/01/2010 83
2. Organising Project Dept.
A project with complex design that requires
innovation is to be finished on time
Large amounts of data are required to be
processed
Designing, developing and testing a product
requires sophisticated skills
Resources have to be shared among different
projects
The market conditions demand rapid changes in
the product

01/01/2010 84
A diagrammatic representation of a Matrix Organisational Structure:






: Vertical Lines: Functional Relationships/Responsibilities;

: Horizontal Lines from PMs (Project Managers) : Project
Relationships/Responsibilities;

: Personnel in the various departments;
PM 1
PM 2

PM 3

General
Manager
General
Admn.
Manager
HR
Manager
Produc
tion
Manager
Marketing/
Sales
Manager
Finance
Manager
2. Organising Project Dept.
• There are three types of Matrix organisations
– Weak, Balanced and Strong.
• Refer to Book by Gray and Larson and
Explain these three forms.
01/01/2010 86
2. Organising Project Dept.
• Selecting an organisational structure: PM has
become a specialised field due to the need for
implementing complex and large projects within
the defined constraints of time, cost,
performance and profit.
• The traditional organisational structure have
proved to be ineffective to deal with the
complexities of Project Management.
• Therefore it is necessary for organisations to
identify the most appropriate organisational
structure for the successful execution of a
project.
01/01/2010 87
2. Organising Project Dept.
• The parameters to be considered while
selecting the type of organisational structure
may generally include:
· size of the project, · duration of the project,
· physical location of the project, · availability
of resources · uniqueness of the project, ·
experience of the organisation in managing
projects and · transparency at the senior
management level

2. Organising Project Dept.
• According to Hobbs and Menard, the following seven
factors influence the choice of PM structure:
1. Size of Project;
2. Strategic importance;
3. Novelty and need for innovation;
4. Need for integration (number of departments involved;
5. Environmental complexity;
6. Budget and time constraints and
7. Stability of resource requirements.
01/01/2010 89
2. Organising Project Dept.
• The Project Management Organisational
Structure:
Every type of organisational structure has its
advantages and disadvantages.
The Project Management approach proves to be
an effective alternative with minimum
disadvantages.
01/01/2010 90
Project Management Organisational Structure
Advantages Disadvantages
Effective project control Lack of consistency in
applying company policies
Improved relationship
with customers
Under utilisation of personnel
Ability to develop
products faster
Low profit margins
Minimum programme
cost
Increases complexity of
internal operations
Improved quality and
reliability
High transfer rate of
personnel among projects
Enhanced profit margins Duplication of functional skills
01/01/2010 91
Advantages….. Disadvantages..
.
Effective and efficient control on
the security of the programme
Improved result orientation
Effective coordination among the
divisions working on the project
Improved morale and goal
orientation among employees
01/01/2010 92
2. Organising Project Dept.
• It should be borne in mind that the change over
to the Project Management structure is a huge
forward leap and going back to the traditional
structure is not possible.
• The Project Management structure brings in an
upgradation of jobs and job profiles.
• After selecting the appropriate structure, it is
necessary to select the personnel required to
work on the project.
• The ‗Right People for the Right Jobs‘ have to be
identified and engaged for the success of the
project.
01/01/2010 93
2. Role of Consultants
• Role of Consultants in Project Management:
+As the economic growth is more than the
development of Infrastructure in India in
particular and Asia in general, the development
of Infrastructure has gained topmost priority.
+Whether it be telecommunications, power,
highways/roads, airports, seaports, water
supply or sewerage disposal, all are lagging far
behind the ideal levels of development as
envisaged under the ‗CMP‘ (Common Minimum
Programme).
01/01/2010 94
2. Role of Consultants
+The Government in the 11th Five Year (2007-
2012) has increased the outlay in Infrastructure
significantly to Rs.17,58,000 Crores (US$ 439.5
Billion) from the 10th Plan figures Rs.8,15,000
Crores (US$ 203 Billion) at 2006-07 Prices.
+The major thrust areas for these investments will
be in Power, Roads and Railways which account
for 2/3rd of the plan outlay in Infrastructure.
01/01/2010 95
2. Role of Consultants
+India‘s Infrastructure investment requirements
until 2010-2011, which includes investments in
the transport, telecommunications, energy, and
urban sectors, is estimated to be about $425
billion. Of this total, there is a $123 billion
anticipated financing gap which is being sought
from the Private Sector. (Study by the
International Project Finance Association-IPFA)
01/01/2010 96
2. Role of Consultants
+To achieve and sustain the required level of
growth, India needs to finance the infrastructure
sector in trillions of rupees.
+In this context, some Consultants specialise in
managing these project operations.
+Consultation has become a good business these
days and all they require to run business is to
acquire experienced employees from different
fields.
+Project Management consulting is one of the
growing consultation businesses since, before
starting any projects, more and more companies
seek the services of consultancy firms for their
project needs, to eliminate risk.
01/01/2010 97
2. Role of Consultants
+Even big companies prefer to hire consultancy
firms though they have to pay more.
+Selecting a consultancy firm for project
management is a little time consuming task as
research is needed to find out which project
management consultancy is the best for the
particular project and even after selecting a
consultancy, deadlines for completion of the
project, fees payable etc. need to be discussed
and finalised.

01/01/2010 98
2. Role of Consultants
• ―It is common today, for a key team member to
be appointed as manager for a business critical
project.
• This individual normally has excellent ―technical‖
knowledge of the project.
• The million $ question is, do they have the
systems, competence and available time, to
project manage professionally?
• The statistics suggest probably not.
• Most project management surveys in the last
decade indicate that many projects fail to
successfully meet their objectives...........
01/01/2010 99
2. Role of Consultants
• ………… – just think of the disappointed
customers, advantaged competitors, and lost
profits that result.
• Those companies who have recognised the
potential for savings have employed dedicated
Project Managers, either interim or on the
payroll, with mixed success.
• Recruitment is the first challenge – what do you
look for? Many business leaders have heard of
qualifications such as APM, PRINCE, PMI, and
the like, but are not sure what they mean.
01/01/2010 100
2. Role of Consultants
• Nor do they understand the relevance and
appropriateness for their business.
• Integration into the business is the next problem:
– are there suitable project management
processes and tools/templates in existence in
the business to be used?
-- or are the Project Managers (PM) left to their
own devices?
• The final big challenge is performance.
• Are the PMs delivering as well as they could and
should?
01/01/2010 101
2. Role of Consultants
• There is a clear need for a framework of
measurement and improvement. This need is
often overlooked.‖
• This is where the professional Project
Management Consultant comes in to perform
and deliver the targeted results.



01/01/2010 102
2. Role of Consultants
+Pricing and cost recovery, generating new sources of
revenues to finance the infrastructure are some of the
critical areas where consultants can provide workable
solutions.
+The 1992 UN Conference on Environment and
Development helped to put sustainable development on
the agenda.
+(See more details in the Notes)
+As a result, environmental consideration plays a very
significant role in development projects, particularly
those relating to infrastructure, and especially if they are
funded by the international lending agencies like the
IBRD or the ADB.
01/01/2010 103
2. Role of Consultants
+Management consultants can meet the
challenge of balancing economic and
environmental considerations in practice, by
assessing the environmental impacts,
suggesting the measures for their mitigation and
identifying the economic costs of environmental
degradation, so that pricing of infrastructure
services takes these costs into account.

01/01/2010 104
2. Role of Consultants
+Consultants can play a significant role in the
transformation process, by acting as an interface
between the bureaucratic government and the
investors waiting for the unsaturated giant
market to wake up.
+There is a lot of scope for the consultant to
support the setting up of legal and organisation
structures to meet the needs and objectives of
the public sector in this regard.

01/01/2010 105
2. Role of Consultants
+To develop and sustain an effective, efficient
and economical administrative machinery, which
is creative and adaptable to the dynamic forces
of the future, it is essential to have suitable
organisation structures, human resources
policies, and systems and procedures, which
should strive to motivate the employees and at
the same time satisfy the public at large.
+The government‘s lack of effective initiatives in
framing an investment-friendly and transparent
framework have kept even the genuine investors
away and confused.
01/01/2010 106
2. Role of Consultants
+Therefore there is an urgent need to have a pool
of knowledge systems which would have
credibility with the government as well as with
the investors.
+Consultants can precisely fill this gap by
providing a multi-disciplinary, multi –functional
and multi-sector think-tank matured with the
experience acquired over the years.
+Management consultancy is about effecting
change. It is in effect, a catalyst and a
multiplier, rapidly dispersing new knowledge,
new skills, and new capabilities through the
economy.
01/01/2010 107
2. Role of Consultants
+Consultants can help to develop a systematic
approach to evaluating the range of institutional
options in the infrastructure sectors to take stock
of the lessons or experience and identify best
practices, and to accelerate and focus the
learning process.
+The challenges from the environment are such
that conventional wisdom and approaches may
not suffice, and have to give way to more
creative solutions.
+It would be worthwhile making consultants
intellectual partners in the effort.
01/01/2010 108
2. Role of Consultants
+In short, the consultants take care of the variety
of tasks in the management of a project, which
can be generally summarised as follows:
= Policy and institutional framework, including
thrust areas for investment, norms for setting up
projects and financing them, organisations
involved, and the regulatory framework-including
centre-state matters;
= Advisory services, such as project formulation,
covering scouting, feasibility and modalities,
liaison and documentation, environmental and
sociological issues, and sectoral expertise;
01/01/2010 109
2. Role of Consultants
= Financing mechanisms, for stakeholders,
including government, debt and/or equity
participation, and alliances, both domestic and
foreign;
= Techno-sociological management synergy, to
bring about collaborative efforts of specialists,
community, government and other stake
holders.
+Thus the consultants with their expertise in all
the areas related to project executions and a
clinical professional approach, play a very
important role in Project Management.
01/01/2010 110
3.Project Identification : Selection of
product
Selection of a Project: A Project or Projects
selected should be integrated with the Strategic
Plan of the Organisation.
• Project Management is at the apex of strategy
and operations.
• The Project Managers need to understand the
Organisation‘s Mission and Strategy.
The Strategic Management Process: ―What we
are?‖ ¬ ―What we intend to be?‖ ¬ ―How we
are going to get there?‖
3.Project Identification : Selection of
product
Four activities of the Strategic Management
Process:
Review and define the organisational Mission;
Set long-range goals and objectives;
Analyse and formulate strategies to reach
objectives and
Implement strategies through projects.
Mission statements may change….Then the
whole strategy has to also change accordingly.
3.Project Identification : Selection of
product
• Characteristics of the objectives ―SMART‖:
¬Be Specific in targeting an objective;
¬Establish a Measurable indicators(s) of
progress;
¬Make the objective Assignable to one person
for completion; (or Achievable)
¬State what can Realistically be done with the
available resources and
¬State when the objectives can be achieved, that
is (Time) duration.
3.Project Identification : Selection of
product
• Effective Project Portfolio Management System:
Avoids THE IMPLEMENTATION GAPS;
Avoids ORGANISATION POLITICS and
Manages RSOURCE CONFLICTS AND
MULTITASKING.
3.Project Identification : Selection of
product
• Classification of the Projects:
¬ Compliance (and must do) (Regulatory or
Emergency);
¬Operational (Improving efficiency of the existing
systems) and
¬Strategic.
3.Project Identification : Selection of
product
• Selection of Projects - Criteria:
¬ Financial and
¬Non financial:  To capture larger market
share; to make it difficult for competitors to
enter the market; to develop complementary
products to develop core technology for use in
next generation products; to reduce
dependency on unreliable suppliers; to
prevent government intervention and regulation.
3.Project Identification : Selection of
product
Selection of Product:
The search for promising project ideas is the first
step towards establishing a successful venture.
 Theoretically, a number of projects are available
for any entrepreneur.
 The key to success lies in getting into the right
business at the right time.
 The identification and implementation of good
ideas contributes significantly to the success of
a project.

01/01/2010 117
3.Project Identification : Selection of
product
 The generation of ideas and opportunities
requires imagination, creativity, sensitivity to the
dynamic external environment and a realistic
assessment of the firm‘s capabilities.
 The Project Manager‘s innovative efforts have to
take into account the ever changing customer-
needs and preferences, new technologies, the
speed at which the products and their
technologies become obsolete, and the existing
and future potential competition.
01/01/2010 118
3.Project Identification : Selection of
product
 The important dimensions which are to be probed
thoroughly before making the choice are:
-Product/service, -market, -technology,
-equipment, -scale of production, -location,
-incentives available and -time phasing.
 Do you recall Porter now?
 Project identification is also concerned with
collection, compilation and analysis of economic
data for the eventual purpose of locating possible
opportunities for investment and for the
development of such opportunities.
01/01/2010 119
Porter‟s 5 Forces Analysis
There is also the sixth force-The
„Complementor‟ - the word coined by Andrew
Grove to denote the Govt. or the Public.
01/01/2010 120
3.Project Identification : Selection of
product
 Drucker classifies the opportunities into three
kinds:
Additive - which enable the decision-maker
to better utilise the resources without in any way
changing the character of business, create
minimum disturbance to the existing state of
affairs and hence the least risk.
Complementary – introduction of new
ideas, and so, lead to a certain amount of
change in the existing structure; and

01/01/2010 121
3.Project Identification : Selection of
product
Breakthrough – fundamental changes in both the
structure and character of business.
 Risk is greater in the ‗complementary‘ but the
most in the ‗breakthrough‘.
 As the risk increases, so is the requirement of
more precise definition of the scope and nature
of the project objectives and the necessity to
select the best possible approach so as to
minimise the resource consumption and risks
and to optimise the return or gains.

01/01/2010 122
3.Project Identification : Selection of
product
• New ideas for projects are thrown up by many
situations, like magazine articles etc. Some
examples are:
The dearth of a particular product or service;
The availability of a specified type of raw
material (Presence of a skilled artisans in an
area…);
Observation of the existing processes (Eg.
A factory using a particular machine deciding to
manufacture the machine itself.)
Analysis of the performance of the existing
industries: profitability, capacity utilisation…
01/01/2010 123
3.Project Identification : Selection of
product
Examination of the inputs (availability, time
lag, transportation costs, economies of scale…),
outputs (resultant by products, wastes…)
Review of Imports and exports (trend, import
substitution…, products which have export
potential….)
The statistics given by the magazines about
the availability of various products;
Research Institutes (CSIR etc…new
technologies,, processes etc…);
01/01/2010 124
3.Project Identification : Selection of
product
The Plan document and various departmental
publications of the Government.
(Annual Publication ‗Guidelines to Industries‘ by
the Dept. of Industrial Development: Structure,
location, production performance, licensed and
installed capacity, exports, various incentives
available, future scope…)
Studies of the State Financial Institutions and
Development Agencies:
(Feasibility studies for establishment of new
industries in various areas in their states…)
01/01/2010 125
3.Project Identification : Selection of
product
Study of the reports of the different Product Group
Manufacturers‘/ Industries‘ Associations;
Analysis of Economic and social trends: (changing
habits of people to use more and more sophisticated
products, indulging in leisure activities…)
Consumption of products in foreign countries which
can fulfil the needs of the local public;
Study of sick units for possibility of revival;
Products reserved for the SSI/SME sector listed by
the Governments for their exclusive purchases.
01/01/2010 126
3.Project Identification : Selection of
product
• The entrepreneur is concerned with identifying a
particular product that can be marketed
successfully at a reasonable profit.
• A good project contains four critical elements:
―The right project at the right time at the right
place and at the right price‖.
• If the entrepreneur himself has adequate
experience in the manufacture and marketing of
certain products, then it would be to his
advantage to select the product/s, subject to the
other criteria being fulfilled.
01/01/2010 127
3.Project Identification : Selection of
product
Identifying the market:
• Out of the many project ideas thrown up from
different sources as discussed above, the market
for the product has to be identified.
• A short list may be made of only those products
which can satisfy the Michael Porter‘s 5 force
model and the Life Cycle approach ( Stages of
a product : Pioneering or Infant, Rapid Growth,
Maturity or Stabilisation and finally the Decline).
• The market can be identified from some of the
sources indicated for selecting the project.
01/01/2010 128
3.Project Identification : Selection of
product
• ―One should either identify a need and fill it or
create a need and fill it‖.
• The classification of the consumers on the basis
of income groups, demography (age groups),
industries, geographical locations, sex will
indicate the potential market.
• Seasonal factors, disposable incomes, ruling
prices, fashion also indicate the potential market.
01/01/2010 129
3.Project Identification : Selection of
product
• The study of the project idea is the starting point
of the feasibility analysis
-- which is undertaken to identify the logic of
the project, the tasks that must be performed
to achieve the objectives, the inputs, the
outputs and the process involved in each
activity.
01/01/2010 130
3. Preparation of feasibility study/report :
• Preparation of feasibility study/report :
• The stating point of a project analysis is the
establishment of objectives to be attained.
The next stage is the pre-selection stage – to
decide whether to go in for an in-depth study or
not.
• A feasibility study is an analysis of the viability of
an idea through a disciplined and documented
process of thinking through the idea from its
logical beginning to its logical end.
01/01/2010 131
3. Preparation of feasibility study/report :
• A feasibility study provides an Investigating
function that helps answer “Should we proceed
with the proposed project idea? Is it a viable
business venture?”
• A feasible business venture is one where
-the business will generate adequate cash flow
and profits,
-the business will withstand the risks it will
encounter,
-the business will remain viable in the long-term,
and
-the business will meet the goals of the founders.
01/01/2010 132
3. Preparation of feasibility study/report :
^Why a Feasibility Study?
• To provide a thorough examination of all issues
and assessment of probability of business
success,
• To give focus to the project and outline
alternatives,
• To narrow down business alternatives,
• To unearth new opportunities through the
investigative process,
• To identify reasons NOT to proceed,
• To enhance the probability of success by
addressing and mitigating factors early on that
could affect the project,
01/01/2010 133
3. Preparation of feasibility study/report :
• To provide quality information for decision
making,
• To help to increase investment in the company,
• To provide documentation that the business
venture was thoroughly investigated,
• To help in securing funding from lending
institutions and other monetary sources.
^Data required for a feasibility study can come
from primary or secondary sources.
• Primary data can include formal interviews and
surveys.
01/01/2010 134
3. Preparation of feasibility study/report :
• Collection of primary data can be expensive and
time consuming
• Secondary data can include industry and trade
publications, statistics of industry associations,
government agency reports (CSO)
^A feasibility study of an idea is conducted at five
levels
01/01/2010 135
3. Preparation of feasibility study/report :
^Financial Analysis : Profitability , BEP, Level of
risk:
×Financial statements: total project cost, initial
capital requirements, cash flows relative to the
project schedule,
×Financial projections for future time periods,:
income statements, cash flows and balance
sheets,
×Supporting schedules for the financial projections,
stating the assumptions made regarding the
collection period of sales, credit period for
purchases and expenses, production cost, selling
and admn. Expenses and financial expenses.
01/01/2010 136
3. Preparation of feasibility study/report :

×Financial analysis showing returns on
investments, returns on equity , break-even
volume and price analysis.
×Sensitivity analysis /Risk analysis to identify
items which have a substantial impact on
profitability.
^Technological Analysis : Scale of operation,
Process chosen, Equipment & Machinery.
×Description of the product including specification
relating to its physical, mechanical and chemical
properties and uses of the product,
01/01/2010 137
3. Preparation of feasibility study/report :
×Description of the selected manufacturing
process, showing detailed flow charts and
presenting alternative processes which may
have been considered and the justification for
the adoption
×Determination of the plant size, and production
schedule, including the expected volume for a
given period on the basis of start-up and
technical factors of the selected process.
01/01/2010 138
3. Preparation of feasibility study/report :
×Selection of machinery, equipment, including
specifications, equipment to be purchased, its
origin, quotations from suppliers, delivery dates,
terms of payment, comparative analysis of
alternatives in terms of cost, reliability
performance and spare parts availability,
×Identification of plant‘s location and an
assessment of its desirability in terms of
distance from raw material sources and markets,
a comparative analysis of different sites,
indicating the advantages and disadvantages of
each.
01/01/2010 139
3. Preparation of feasibility study/report :
×Design of the plant layout and an estimate of
the cost of the proposed buildings and land
improvements,
×Availability of the raw materials and utilities
including a description of physical and chemical
properties, quantities needed, current and
prospective costs, terms of payment, location of
sources of supply and continuity of supply,
×Estimate of labour requirements, including a
detailed break-down of direct and indirect labour
requirements, and the supervision required for
the manufacture of the product,
01/01/2010 140
3. Preparation of feasibility study/report :
×Determination of the type and quantity of waste
to be disposed of together with a description of
the waste disposal method, its costs, and the
necessary clearance from proper authorities,
×And an estimate of the production cost of the
product, etc…
^Economical Analysis : From the point of view of
the Society, Impact on society, Impact on saving
& investment.
×Contribution to the national economy: raising of
aggregate consumption, redistribution of
income.
01/01/2010 141
3. Preparation of feasibility study/report :

^Market Analysis : Aggregate demand, Market
share.
×The market analysis should cover the following
areas:
×A brief market description including the market
area, modes of transportation and costs,
channels of distribution, and general trade
practices;
×An analysis of past and present demand,
determination of quantity, value of consumption
and identification of the major consumers of the
product;
01/01/2010 142
3. Preparation of feasibility study/report :
×An analysis of past and present supply, broken
down as source – whether imported or domestic-
as well as information to assist in determining the
competitive position of the product, such as selling
prices, quality and marketing practices of
competitors.
(projections for the future also are required for the
above factors).
^Ecological Analysis : Effect on environment
damage, Cost to prevent the damage:
×Study of different types of potential environmental
pollution: gaseous emissions, noise heat and
vibrations while manufacturing of the product and
disposing of the wastes/effluents.
01/01/2010 143
3. Preparation of feasibility study/report :
×Cost of restoration in the unfortunate event of
damages (eg. Union Carbide…)
01/01/2010 144







Generation of
ideas
Initial
Screening
Is the idea Prima Facie
Promising?
Plan Feasibility
Analysis
Yes
Terminate
No
Conduct Market
Analysis
Conduct Technical
Analysis
Conduct Financial Analysis
Conduct Economic and Ecological Analysis
Is the Project worthwhile ?
Prepare Funding
Proposal
Terminate
Yes
No
P
R
E
L
I
M
I
N
A
R
Y

W
O
R
K

A
N
A
L
Y
S
I
S
E
V
A
L
U
A
T
I
O
N
Feasibility Study – A Diagrammatic Representation
01/01/2010 145

3. Project Rating Index:

^Project Rating Index:
×The preliminary evaluation results of various
projects in view may be translated into a Project
Rating Index. How to do it?
×Identify the factors relevant for the project rating,
×Assign weights to these factors depending upon
their relative importance and criticality,
×Rate the project proposals on various factors,
using a rating table,
( a 5, 7 or 10 or any desired scale may be used),
01/01/2010 146
3. Project Rating Index:

×For each factor, multiply the factor weight with
the assigned rating and note the score,
×Add all the factor scores to arrive at the overall
Project Rating Index,
×Compare the Project Indices of the various
short-listed projects with the pre-determined
desired minimum Rating,
×Select the best of the projects whose ratings
exceed the predetermined minimum rating.
3. Project Rating Index:

• Refer to text books to see the numerical
example of project ratings.
01/01/2010 148
4. Project formulation.
• Project Formulation techniques help in making
the final choice of a project.
• Project formulation is the presentation of the
Project idea which makes it easy to compare
with the other project ideas.
• Project Formulation (PF) is defined as taking a
first look carefully and critically at a project idea
by an entrepreneur to build up an all round
beneficial project after carefully weighing its
various components.
• The aim of project formulation is to derive
maximum benefits from minimum expenses in a
short span of time.
01/01/2010 149
4. Project formulation.
• Steps in Project Formulation: Recall what we have
already seen earlier:
• A project comprises of a series of activities for
achieving a predetermined objective or a set of
objectives.
• And therefore the objective(s) should be defined
as precisely as possible.
• Objectives may be General or may be
Operational.
• A general objective merely states in broad terms
the achievements expected whereas an
operational objective specifically mentions the
results expected from the implementation of the
project.
01/01/2010 150
4. Project formulation.
• The next stage is about the location and size of the
project.
• The seven distinct sequential stages in Project
Formulation are:
• 1.Feasibility Analysis: At this stage, the project idea is
examined to decide whether to go in for a detailed
investment proposal or not.-(Technical Feasibility;
Economic Viability; Commercial Feasibility; Financial
Feasibility; Organisational Aspects; Legal Aspects)
• (If feasible: proceed to the next step; If not feasible: drop
the project idea; If unable to decide for want of sufficient
data: Collect more data).
01/01/2010 151
4. Project formulation.
• 2.Techno-Economic Analysis: Estimation of the
project demand potential and choice of optimal
technology are made.
The Techno-Economic analysis gives the
project a unique individuality and sets the stage
for detailed design development.
• 3.Project Design and Network analysis : This
step defines the individual activities which
constitute the project and their inter-relationship
with each other.
 A detailed work plan of the project is prepared
with time allocation for each activity and
presented in a network drawing.
01/01/2010 152
4. Project formulation
Project design is a critical element of the project
and paves the way for a detailed identification
and qualification of the project inputs, which are
essential to develop the financial and cost-
benefit profile of the project.
• 4.Input Analysis : This step assesses the input
requirements during the construction as well as
during the operation of the project.
The details of the inputs required at each stage
should be prepared to arrive at the total
requirements of the inputs for the project-both
quantitatively as well as qualitatively.
01/01/2010 153
4. Project formulation
Both recurring and non-recurring requirements
of inputs are taken into account.
An evaluation is made from the point of view of
the availability of the required resources.
This will help in arriving at the project cost which
in turn will help a proper financial and cost-
benefit analysis.
• 5.Financial Analysis: This stage involves
estimating the project costs, operating costs and
funding requirements.
 It also helps comparing different projects on a
common scale.
01/01/2010 154
4. Project formulation
The tools used are DCF, CVP and Ratio
analysis.
Since project investments are for long time
horizons, it is absolutely necessary to exercise
due care and foresight in developing project
financial forecasts.
• 6.Social Cost Benefit Analysis: While Financial
analysis will justify a project from the point of
view of profitability, the Cost-Benefit Analysis
will consider the project from the national
viability point of view.
01/01/2010 155
4. Project formulation
In this analysis, we not only consider the
apparent direct costs and direct benefits of the
project, but also the costs which all entities
connected with the project have to bear and the
benefits which will be enjoyed by all such entities.
This strategy is now an international norm for
project formulation.
• 7.Pre Investment Analysis: The project proposal
gets a final shape at this stage.
All the results obtained from the previous stages
are consolidated and various conclusions are
arrived at to present a clear picture.
01/01/2010 156
4.Evaluation of Risks:

 At this stage, the project is presented in such a
way that the project sponsors, the implementers
and the external consulting agencies are able to
take a final decision as to whether to accept the
project proposal or not.
• Evaluation of Risks:
×Risk is the possibility of an outcome being
different from the expected outcome, the
possibility of adverse results flowing from
the uncertainty involved in carrying out the
activities.
01/01/2010 157
4.Evaluation of Risks:
×Every activity of a project is exposed to some
degree of risk. Project is a function of
uncertainty and damage.
×Both these factors should be thoroughly
examined while conducting the risk analysis.
×The project manager should also provide for
hazards and the appropriate safeguards to
mitigate the risks.
4.Evaluation of Risks:
• Based on the principle that a risk has two
primary dimensions:
• Probability - A risk is an event that "may" occur.
The probability of it occurring can range
anywhere from just above 0% to just below
100%. (Note: It can't be exactly 100%, because
then it would be a certainty, not a risk. And it
can't be exactly 0%, or it wouldn't be a risk.)
• Impact - A risk, by its very nature, always has a
negative impact also. However, the size of the
impact varies in terms of cost etc.
4.Evaluation of Risks:
• The chart has these characteristics:
• Low impact/Low probability - Risks in the bottom left
corner are low level, and you can often ignore them.
• Low impact/High probability - Risks in the top left
corner are of moderate importance - if these things
happen, you can cope with them and move on. However,
you should try to reduce the likelihood that they'll occur.
• High impact/Low probability - Are of high importance
but they're very unlikely to happen. For these, however
you should have contingency plans in place.
• High impact/High probability - These are your top
priorities, and are risks that you must pay close attention
to.

4.Evaluation of Risks:
×Some of the risks that arise in a project are:
+1.Technical risks: These risks refer to the failure
to meet a particular performance requirement.
· Failure of the feasibility of a design, changes in
technology etc. are some of the sources.
· Software modules running well in small scale fail
when integrated with some other modules.
· Technology obsolescence before the project is
ready to start commercial production
01/01/2010 162
4.Evaluation of Risks:
2.Social risks: Changes in the needs and
preferences of the target customers.
· Labour unrest, strikes, and social movements
against the project (Example: Population
displaced due to acquiring of land for a new
project).
+3.Economic Risks: Increase in the rate of
inflation, changes in the economic policies of the
government.
· No control of project manager over these risks
and so extra provisions while preparing
projections even at planning stage.

01/01/2010 163
4.Evaluation of Risks:
+4.Political risks: Nationalisation or privatization
of an industry. Political instability.
· (The project manager should analyse the
policies of the ruling party as well as the main
opposition party)
01/01/2010 164
4.Evaluation of Risks:
+5.Production risks: Shortage of necessary RM,
breakdown of machinery, rise in installation and
maintenance costs.
· (These can be generally forecast at periodic
intervals and hence safeguards can be built
into the plan).
+6.Marketing risks: Failure of the developed
product or service in the market due to changes
in the market demand, errors in forecasting the
demand at the planning stage…
· (The Project manager should change the
strategy)
01/01/2010 165
4.Evaluation of Risks:
+7.Financial risks: Bad debts, increase in interest
rates, mistakes in accounting procedures.
· (Project manager has to constantly assess the
project on these parameters so as to take
corrective actions.)
+8.Human risks: Sudden demise or resignation
of key employees, non availability of competent
employees, inter-group politics and rivalry
among employees.
01/01/2010 166
4.Evaluation of Risks:
· (Project manager should evolve suitable HR
policies and implement them and also take
group insurance schemes to reduce the
sufferings of the families of the deceased
employees)

01/01/2010 167
4.Risk Management
+Risks can never be avoided completely.
Appropriate tools have to be used effectively to
mitigate the risks.
+The timing and use of the tools depends on the
‗risk tolerance‘ level of the project manager.
+Project managers may be ‗risk averse‘ or ‗risk
neutrals‘ or ‗risk seekers‘.
+When the investment amount goes up, the
utility-the satisfaction-- that the project manager
gets—of the risk averse project manager
increases at a decreasing rate.
01/01/2010 168
4.Risk Management
+For a risk seeking project manager, utility
increases at an increasing rate as the
investment at stake goes up.
+The risk neutral project manager‘s utility lies in
between the other two.
+The PMBOK defines risk management as “the
formal process by which risk factors are
systematically identified, assessed, and
provided for.”
+The project manager has to be proactive rather
than reactive while dealing with risks.
01/01/2010 169
4.Risk Management
+The proactive project manager anticipates the
risks and is ready with contingency plans
whereas the reactive project manager waits for
the risk to become visible as a problem and
then starts thinking of solving the problem.
+Certainty, risk and uncertainty:
o Project managers have to take many decisions
under conditions of certainty, risk and
uncertainty.
o Decision making is easy in conditions of
certainty.
01/01/2010 170
4.Risk Management
o The process becomes increasingly difficult as
the condition changes from certainty to risk and
to uncertainty as the expected potential damage
to the project increases.
o Decision making under certainty:
o The project manager is fully aware of all the
states of nature (the future events that are not in
the control of the project manager) available and
the expected payoffs for each state of the
nature.
o The project manager can construct a payoff
matrix for all the states of nature and select the
best possible strategy.
01/01/2010 171
4.Risk Management
o First the project manager formulates the strategy
for each of state of nature.
o Then all the possible outcomes for each action,
under each state of nature are recorded to
complete the payoff matrix.
o Homework: Prepare a sample pay off matrix
for decision making under certainty. (See
Chapter18 of IC).
o Decision making under risk: PMBOK: ―Risk is
the totality effect of outcomes (i.e. states of
nature) that can be described within established
confidence limits (i.e. probability distributions).
01/01/2010 172
4.Risk Management
o Under conditions of risk, the project manager
can assign probability of occurrence to each
state of nature with which he can also calculate
the expected value for each of the strategies
and finally select the best strategy earning
higher returns.
o The expected value of a strategy is the sum of
the products of the probability of a state of
nature and the respective payoff value of a
strategy. Homework: Construct a sample payoff
matrix for decision making under risk.
01/01/2010 173
4.Risk Management
o Decision making under uncertainty: In this case
the project manager does not know the
probability of occurrence of each state of nature.
o He uses four types of criteria to select a
strategy:
• Maximax criterion (Hurwicz criterion): The
project manager chooses the strategy that is
likely to earn him the highest returns;
• Maximin criterion (Wald criterion): The project
manager identifies the minimum payoff values of
each strategy and adopts the strategy that has
the highest payoff value.
01/01/2010 174
4.Risk Management
• Minimax regret criterion: The project manager attempts
to minimise the maximum regret value (maximum
opportunity loss).
• The regret value is arrived at by subtracting the pay off
values in each state of nature from the largest payoff
value of that state of nature. (The matrix is created from
the matrix of decision making under risk)
• Criterion of realism. (Laplace criterion) : As per this
criterion, each state of nature has the same probability
of occurrence.
• So the project manager considers the average value of
all the payoffs for each strategy and selects the strategy
that has the average highest payoff.

01/01/2010 175
4.Risk Management
×Decision Tree analysis: This analysis is used
when a decision involves a series of several
unrelated decisions. The project manager
computes the Expected Monetary Value (EMV)
of all strategies and chooses the strategy with
the highest EMV.
×Homework: Prepare a sample Decision Tree.

01/01/2010 176
4.Risk Management
• Risk Management Methodology: Steps involved:
• Risk identification: Source of risks, potential
risk events, and risk symptoms.
• Risk quantification: Decision trees, simulation,
PERT and CPM, Probability distribution.
• Risk response: Risk avoidance, Risk transfer,
Risk mitigation and Risk acceptance.
• Risk control: Corrective actions, Updates to risk,
Management Plan.
The Risk
Management
Process
01/01/2010 178
4. Preparation of Project Report:
• Preparation of Project Report:
• Usually, the project report is prepared before the
investment in the project is undertaken, as it is
the basis on which the whole project proceeds
and the financiers also assess the project‘s
viability on the basis of the project report, so as
to take the decision whether to lend or not.
• The project report records the merits and
demerits in allocating resources to production of
specific goods or services.
• It gives a complete analysis of the inputs and
outputs of the project.
01/01/2010 179
4. Preparation of Project Report:
• Usually the promoter of the project gets the
report prepared by consultants who are
experienced in the line and that too in the areas
of the product or service proposed in the project.
• The Scope of the project report covers the
following aspects:
• Economic aspects: Economic justification for
investment, analysis of the market :
×how big is the present market and potential for
future growth?
×what could be the market share in future
assuming new entrants?..
01/01/2010 180
4. Preparation of Project Report:
• Technical aspects: Details about the technology
needed and where it is presently used
successfully, equipments and machinery
needed, their suppliers and report about their
performance efficiency..
• Financial aspects: Total investment required,
breakup of promoter‘s contribution, sources of
finance for the balance viz, equity/preference
equity from public, debentures, term loans, cost
of capital , return on equity, return on
investment, cash flows for the tenure of the loan
sought, D/E ratio, DSCR….
01/01/2010 181
4. Preparation of Project Report:
• Production aspects: Description of the product
selected, its design, and the reasons for the
selection, whether can be exported and if so,
which are the markets…..
• Managerial aspects: Qualifications and
experience of the key management team in the
line of the product or service..
×(Production Manager, Marketing/Sales
Managers, Purchase manager, HR manager,
other managers well conversant with Labour
laws, Factory acts, tax laws and other laws
concerned with running such establishments)
01/01/2010 182
4. Preparation of Project Report:
• The contents of a project report will consist of
the following:
-Objective and scope of the report;
-Product characteristics;
-Market position and trends (installed capacity,
production and anticipated demand, export
prospects, price structure and trends);
-Marketing channels (trading practices and
marketing strategy);
-RM ( requirement in quantity, prices, sources of
supply and their properties, transportation);
01/01/2010 183
4. Preparation of Project Report:
-Manufacture (process, selection of process,
production schedule and technique);
-Plant and machinery ( equipments, machinery,
instruments, lab equipments, electric load, water
supply);
-Land and building (land area, building,
construction schedule);
-Personnel (requirements of staff at various
levels, labour and their availability, cost of
labour..)

01/01/2010 184
5.Selection of location and site of the
project:
• Selection of location and site of the project:
• Location of the site and plant are critical to the
operation of the set up in an interruption-free
manner.
• An ideal site not only saves on costs but also
enhances productivity and profits.
• The need for a new location arises when:
1. an enterprises starts a new project for
production of a product or service;
2. an existing enterprise goes for an expansion of
capacity or diversification of its product range
and the existing location cannot accommodate
additional work space;
01/01/2010 185
5.Selection of location and site of the
project:
3. a necessity arises to shift the existing plant to
another location due to various factors – like
depletion of raw materials in near by areas, or
lease of the land expires and the co. is unable
to extend the lease etc.
• A good location enables the enterprise to
function smoothly, efficiently and with minimum
cost. whereas wrong location leads to
wastage in efforts and talents of the promoters.

01/01/2010 186
5.Selection of location and site of the
project:
• According to Bethel, Atwater and Smith,
enterprise location involves three main steps
which are: 1.Selection of the region or general
area; 2. Selection of a particular community or
locality and 3. selection of the exact optimum
plant site.
• Sometimes the choice of the location is not that
of the promoters but that of the Government due
to licensing regulations (example: Chemical
Zone, Pharmaceutical Zone etc).


01/01/2010 187
5.Selection of location and site of the
project:
• Location is extremely important from another
point of view also: availability of social
infrastructure like, reasonably good housing,
schools/colleges, hospitals, recreation facilities
etc. if best talent is to be attracted and retained.
• In the case of export oriented industries, location
near an airport/sea port would be preferred.
• Power hungry industries should avoid power
deficit locations. (Example: Aluminium Industry)
01/01/2010 188
5.Selection of location and site of the
project:
• Nearness to a heavy industrialised area has its
advantages in respect of infrastructure but has
also a disadvantage in the form of spread of
unionism, even if the employees may not have
any grievance against he unit.
• The factors affecting the location of an
enterprise can be listed as follows:
Urban Area Rural Area
•Possible to find existing
building to house factory.
•Cost of land is less &
scope of future expansion is
more.
•Easier to sell building
later.
•Healthy & pleasant
atmosphere.
•Power & water easily
available.
•Cheapness of land allows
freedom for most economic
design for building.
•Good market for small
mfrs.
•Lesser taxes & restriction.
•Housing, banks, fire
protection, railways &
education available.
•Housing can be
provided by pvt.
Enterprise or local
authority.
•Transportation is easy &
cheap.
•Road or rail connection
can be arranged easily.
•Workers find easy to change
job & area has good labour
market.
•Less labour trouble &
labour is cheap.
•Repairing facility available
with existing industries.
•Opportunity to exchange
knowledge from nearby
industries.
Urban area Rural area
•Climate is not healthy due
to congestion.
•Sufficient power & water
may not be available.
•Arranging equipment is
not possible due to limited
area.
•Enough facilities for
expansion may not be
available.
•High taxes. •No recreational facilities.
•Cost of land is high &
scope of expansion is less.
•Transport & housing
facilities may not be
satisfactory.
•More problems about
labour & employee
relations
•Government facilities may
not be sufficient.
•Cost of building factory
will be high.
•Skilled workers are not
easily available.
•Higher wages of labour
due to high standard of
living.
•Educational facilities may
not be available.
Urban area Rural area
•Climate is not healthy due
to congestion.
•Sufficient power & water
may not be available.
•Arranging equipment is
not possible due to limited
area.
•Enough facilities for
expansion may not be
available.
•High taxes. •No recreational facilities.
•Cost of land is high &
scope of expansion is less.
•Transport & housing
facilities may not be
satisfactory.
•More problems about
labour & employee
relations
•Government facilities may
not be sufficient.
•Cost of building factory
will be high.
•Skilled workers are not
easily available.
•Higher wages of labour
due to high standard of
living.
•Educational facilities may
not be available.
01/01/2010 192
Selection of Region Selection of Community/location
Availability of RM Availability of labour
Nearness to market Civic amenities for workers
Availability of power and fuel Existence of complementary and
competing industries
Transport Banking/Finance and Research
facilities
Suitability of climate Availability of water and fire fighting
facilities
Government policy Local taxes and restrictions
Competition among states Momentum of an early start
Meteorological conditions and
topography
Communication facilities
Cultural affinity and harmony
Religious and social institutions
Educational environment
Historical factors
Political stability

01/01/2010 193
Selection of site Optimum selection of site
Soil, size and topography
Waste disposal
Price of land, right and title of the land
Potential for expansion
Commercial services/Communication
facilities
Health of locality, good scenery
Statutory considerations
Flood and drought experience
Attitude of local people
State Assistance
Optimum site is selected on the basis
of a comparative economic survey of
the alternative sites in aquestion.

01/01/2010 194
5.Selection of location and site of the
project:
• Generally speaking, if the value addition is low,
then the location may be near the source of RM,
(For e.g.: Textile and sugar mills in Maharashtra,
Sugar factories in U.P, Marble mfrg. in Jaipur,
Sandal Wood products in Mysore, fish-canning &
salt pans near coast, Export of Alphonso
mangoes from Ratnagiri.)
• --but if the value addition is high then the
location may be chosen considering the other
more important critical factors since
transportation costs can be absorbed.
01/01/2010 195
5.Selection of location and site of the
project:
• A recent survey found that most of the SMEs had
their location near their residence and had ignored
the economics of the location of the industry. More
than 50% of these SMEs had failed within five
years.
• There are two types of measures that may be
adopted by the Govt. to influence the location: They
are: Positive measures and Negative measures.
• POSITIVE measures encourage growth by various
inducements extended to the industrialists to setup
their projects in certain specified areas.
• NEGATIVE measures impose restrictions on the
location of projects in certain congested areas.
01/01/2010 196
5.Selection of location and site of the
project:
• Both sets of measures are necessary for the
effective location policy.
• If more resources are invested in one region,
less resources will be available for investment in
other regions.
• In cities with population of more than 1 million,
there is no requirement of obtaining industrial
approvals from central government, if the plant is
to be located beyond 25 Kms. of periphery of the
cities.
01/01/2010 197
5.Selection of location and site of the
project:
• Weber‘s Theory of Industrial Location: (Alfred
Weber: was a professor at the University of
Heidelberg from 1907 to 1933):
• Two types of materials used in an industry:
• Ubiquitous: available everywhere- like brick,
clay, water etc.
• Localised materials (which are available only in
certain localities –like ores minerals etc.): again
these are of two types : weight losing and weight
gaining.
01/01/2010 198
5.Selection of location and site of the
project:
• Weight losing materials lose considerable weight
during the process of manufacture- like, coal.
• Such industries should be located near the
source of RM
• Weight gaining materials are those which
become heavier than the raw materials after
manufacture- for example, water added to the
raw material to make the final product. and
require transport.
• Such industries should be located near the
market.
01/01/2010 199
5.Selection of location and site of the
project:
• Industries get redistributed in different localities
due to the ‗deglomerative‘ forces.
• „Agglomeration‟ is the phenomenon of spatial
clustering, or a concentration of firms in a
relatively small area.
• The clustering and linkages allow individual
firms to enjoy both internal and external
economies.
• Auxiliary industries, specialized machines or
services used only occasionally by larger firms
tend to be located in agglomeration areas, not
just to lower costs but to serve the bigger
populations.
01/01/2010 200
5.Selection of location and site of the
project:
• „Deglomeration‟ occurs when companies and
services leave because of the diseconomies of
industries‘ excessive concentration.
• Firms who can achieve economies by increasing
their scale of industrial activities benefit from
agglomeration.
• However, after reaching an optimal size, local
facilities may become over-taxed, lead to an
offset of initial advantages and increase in
Project cost
• Then the force of agglomeration may eventually
be replaced by other forces which promote
deglomeration.
01/01/2010 201
5.Selection of location and site of the
project:
• His theory has five assumptions.
• His first assumption is known as the isotropic
plain assumption. This means the model is
operative in a single country with a uniform
topography, climate, technology, economic
system.
• His second assumption is that only one finished
product is considered at a time, and the product
is shipped to a single market.
• The third assumption is raw materials are fixed
at certain locations, and the market is also a
known fixed location.
01/01/2010 202
5.Selection of location and site of the
project:
• The fourth assumption is that labor is fixed
geographically but is available in unlimited
quantities at any production site selected.
• The final assumption is that transport costs are a
direct function of weight of the item and the
distance shipped.
• Selection of the most Economic site: According
to Kimball, ―the most advantageous location is
that at which the cost of gathering material and
fabricating it plus the cost of distributing the
finished product to the customer will be
minimum‖.
01/01/2010 203
Selection of Actual Site:

Items of cost Cost per unit at the
site
Site A Site B Site C
Fixed Capital (Land, building,
equipment..)
Cost of production and
distribution: ( Materials cost,
Labour cost, Overheads-
taxes, insurance,
depreciation)
Total:
01/01/2010 204
5.Selection of location and site of the
project:
^In order to arrive at the final decision for the
most economic site, a comparative statement as
shown above has to be prepared for all the
alternative sites.
• Factory Layout Planning:
• Factory Design – it is the plan for a particular
type of building, arrangement of machinery and
equipment, and provision of service facilities,
lighting, heating, ventilation, etc. in the building.
01/01/2010 205
5.Selection of location and site of the
project:
• It influences the operational costs, boosts the
morale of the workers and ensures maximum
supervision.
• It must be flexible so that it may be easily adapted
to technological change, modernization,
diversification and expansion with minimum cost
and time.
• Factors to be considered –
• Knowledge of what is involved in the activity
concerned, such as the nature of materials to be
handled………
01/01/2010 206
5.Selection of location and site of the
project:
• ,………. their quality and quantity, the process
they have to be subjected to, inspection and
quality control at various stages, assembly
procedures, packing, etc.
• The sequence of operations
• Movement of materials from one stage to
another should be minimum.
• Plant layout – is a floor plan for determining and
arranging the desired machinery and equipment
of a plant in one of the best place.......
01/01/2010 207
5.Selection of location and site of the
project:
• …….. to permit the quickest flow of materials at
the lowest cost and with the least amount of
handling in processing the product from the
receipt of the raw materials to the shipment of
the finished products.
• It not only covers the initial layout of machines
and other facilities but encompasses
improvement in, or revision of, the existing
layout in the light of subsequent developments
in the methods of production.
PLANT
MARKET/VENDORS
WASTE DISPOSAL
ELECTRICITY
WIRES
CLIMATIC CONDITIONS
GAS
WATER
HOUSE FOR LABOURERS
RAW MATERIAL
SCHOOL
GYMKHANA
SPORTS
BANK
COMPETITORS
REGION
LOCALITY
01/01/2010 209
MEASURE OF SIZE
INPUT
(a.) Net worth
(b.) Size of assets
(c.) Employment
(d.) Raw materials
required
(e.) Power needed
(f.) Number and capacity
of plant
OUTPUT
(a.) Volume of
output
(b.) Value of
output
01/01/2010 210
5.Selection of location and site of the
project:
Factors for evaluating Plant Layout:
• Production technology and Product-mix
• Efficient, economic and uninterrupted flow of
human and materials resources
• Proper space for maintenance
• Future expansion / diversification of the project
• Safety precautions particularly when explosive
or bulky material is required to be handled
01/01/2010 211
5.Selection of location and site of the
project:
• Proper lighting and ventilation
• Proper layout of utilities and services and
provisions for effluent disposal
• Effective supervision of work
• Proper storage and stacking space
Importance of Layout:
• Effective use of available area
• Minimization of production delays
• Improved quality control
• Minimum equipment investment
• Avoidance of bottlenecks
01/01/2010 212
5.Selection of location and site of the
project:
• Better production control and supervision
• Improved utilization of labour
• Improved employee morale
• Maximization of production
• Avoidance of unnecessary and costly changes
• Increased revenues and profits
• Success of the enterprise
01/01/2010 213
5.Selection of location and site of the
project:
Factors affecting Factory Layout:
• Nature of product (light or heavy products)
• Volume of production (high or low)
• Materials handling
• Type of equipment (specifications of machinery
and equipment–general / specialized machines)
• Factory building
• System of manufacture (i.e. process of
manufacture)
• Lighting and ventilation
01/01/2010 214
5.Selection of location and site of the
project:
• Service facilities (canteen, drinking water, toilets,
first aid, fire escapes, etc)
Materials Handling:
• ―The right equipment, at the right position, to be
worked in the right manner for completing the
manufacturing process in the SHORTEST
possible time.
• This includes that the layout should be such that
the new materials, stores, intermediate stores
and work places should be interlinked so that
the production may flow uninterruptedly.
01/01/2010 215
5.Selection of location and site of the
project:
• A good layout not only improves material
handling operations but also increases the
production and productivity per employee.
• Handling adds nothing to the value of the
product, but only to the cost.
Advantages of Materials Handling:
• Reduced labour cost
• Increased capacity of existing building
• Better machine utilization
01/01/2010 216
5.Selection of location and site of the
project:
• Less capital tied-up in work-in-progress
• Easier stock control
• Less fatigue for operations
• More efficient production control
• Better inspection and control of quality
• Improved safety



5.Selection of location and site of the
project:
In short a Good Plant layout can be defined as:
• ―a floor plan for determining and arranging the
desired machinery and equipments of plant,
whether established or contemplated in the best
place, permit the quickest flow of material at the
lowest cost and with the least amount of handling
in processing the product from the receipt of the
raw material to the shipment of finished goods‖
‘S’ Type
R
FG
Combination of ‘T’ and ‘U’ Type
FG
R
‘O’ Type or Circular Flow
R
FG
FG
R
Ground Floor
FG
R
First Floor
Second Floor
Third Floor
01/01/2010 220

6.Policies of Central and State
Governments towards location, Legal
aspects of Project management

As per World Economic Forum‟s Global
Competitiveness Review 2010-11: 139 countries
compared.











Parameter Rank -India Rank-China
Quality of Education System 39 – 4.3/7 53 – 4/7
Quality of Management Schools 23 – 5.1/7 63 – 4.2/7
Availability of specialised research and
training services
51 – 4.4/7 50 – 4.4/7
Intensity of local competition 30 – 5.4/7 19 – 5.6/7
Extent of market dominance 26 – 4.7/7 23 – 4.8/7
Extent and effect of taxation 36 – 4/7 29 – 4.1/7
Number pf procedures required to start a
business
121 -13 126 -14
Time required-no. of days- to start a business 93 - 30 108 - 37
Parameter Rank -
India
Rank -
China
Prevalence of Trade barriers 96 – 4.2/7 69 -4.6/7
Prevalence of foreign ownership 81 – 4.6/7 103 -4.4/7
Business impact of rules on FDI 46 – 5/7 18 – 5.4/7
Burden of customs procedures 81 – 4/7 46 – 4.5/7
Pay and productivity 61 – 4/7 15 – 4.7/7
Reliance on Professional
Management
49 – 4.7/7 50 – 4.7/7
Brain Drain 34 – 4.3/7 37 – 4.3/7
Availability of Financial Services 45 – 5.1/7 71 – 4.6/7
Financing through local Equity
Market
10 – 4.7/7 52 – 3.8/7
Ease of access to loans 39 – 3.3/7 51 – 3/7
Parameter Rank -
India
Rank -
China
Venture Capital Availability 31 – 3.1/7 27 – 3.3/7
Restriction on Capital Flows 75 – 4.4/7 123 – 3.3/7
Soundness of Banks 25 – 5.8/7 60 – 5.3/7
Regulation of Securities Exchanges 15 – 5.3/7 61 – 4.4/7
Availability of latest technologies 41 – 5.6/7 94 – 4.4/7
Domestic Market Size Index 4 – 6.1/7 2 – 6.6/7
Foreign Market Size Index 4 – 6.2/7 1 – 7/7
GDP (PPP) 4 2
Exports as a percentage of GDP 117 – 20.6 88 – 27.9
Business – Local Supplier Quality 60 – 4.6/7 54 – 4.7/7
Nature of (International)
Competitive advantage
61 – 3.4/7 48 – 3.7/7
Parameter Rank -
India
Rank -
China
Production Process sophistication 43 – 4.3/7 55 – 3.9/7
Quality of Scientific Research
Institutions
30 – 4.7/7 39 – 4.3/7
Availability of Scientists and
Engineers
15 – 5.2/7 35 – 4.6/7
Utility Patents per million population 59 – 0.6 51 – 1.2
The report contains ranking of 139 countries on 12 broad
parameters (listed in the next slide) (and sub-parameters
under them). Only a few have been listed above so as to give
a rough idea of where we stand which in turn will give some
ideas as to the areas in which projects can be thought of. See
the website of World Economic Forum for the full text of the
report.

This table is from the last year‘s report
01/01/2010 226
6.India .. At present:
• Sourced from: The Secretariat of Industrial
Assistance (SIA), (Dept. of Industrial Policy and
Promotion-DIPP, Ministry of Commerce and
Industry).:
• Brand India: R & D base for 100 of the 500 Fortune
Companies.
• Among the only three Asian countries with super
computing competence.
• Strong Base for manufacturing: Most MNCs like
Toyota, Volvo, Ford, GM etc source components
from India and also manufacture in India; Hyundai‘s
car manufacturing facility in India is the global base
for exports of its small cars.
• Hero Honda is the world‘s largest motorcycle
manufacturer.
01/01/2010 227
6.India .. At present:
• Abundant availability of untapped natural
resources, rich mineral base, and agricultural
self-sufficiency.
• Large and expanding consumer market with
increasing purchasing power for branded
consumer products.
• Large manufacturing capability, spanning almost
all areas of manufacturing activities, unskilled,
semi skilled and skilled labour availability at
competitive wages.
01/01/2010 228
6.India .. At present:
• All the above are statements of facts and made
possible by the proactive steps taken by the
Govt. of India by liberalising and globalising the
Indian economy.
6.Industrial Policy..
DIPP: Established in 1995 -- Responsible for
formulation and administration of industrial
policy.
Functions:
1. Monitoring industrial growth – infrastructure,
technology, environment etc
2. Approval of Foreign Technology collaborations
and forming policies
3. Formulation of FDI policy
4. Promotion of Non Resident Investment
5. Policies related to IPR, Trademark, Patents etc
6. Development of Industrial corridors as well as
backward states
01/01/2010 230
6.Industrial Policy..
Main features of the Industrial Policy of Govt. of India:
Objectives:
• to maintain a sustained growth in productivity;
• to enhance gainful employment;
• to achieve optimal utilisation of human resources;
• to attain international competitiveness and
• to transform India into a major partner and player
in the global arena.
Policy focus is on :
• Deregulating Indian industry;
• Allowing the industry freedom and flexibility in
responding to market forces and
• Providing a policy regime that facilitates and
fosters growth of Indian industry.
01/01/2010 231
6.Industrial Policy..
Policy measures:
• Some of the important policy measures announced
and procedural simplifications undertaken to pursue
the above objectives are as under:
• i) Liberalisation of Industrial Licensing Policy
• The list of items requiring compulsory licensing is
reviewed on an ongoing basis. At present, only five
industries are under compulsory licensing mainly on
account of environmental, safety and strategic
considerations.
• (1.Alcoholics drinks; 2.Cigarettes and tobacco
products; 3.Electronic Aerospace and Defence
equipment; 4.Explosives; 5.Hazardous Chemicals
such as Hydrocyanic Acid, Phosgene, Isocyanates
and Di-Isocyanates of Hydrocarbon and
derivatives)
01/01/2010 232
6.Industrial Policy..
At present, industrial license is required only for the
following: -
1. Industries retained under compulsory licensing
2. Manufacture of items reserved for small scale
sector by larger units
3. When the proposed location attracts locational
restriction
Similarly, there are only three industries reserved for
the public sector.
• (1.Arms & Ammunition and the allied items of
defence equipments, defence air-crafts and
warships; 2.Atomic Energy; 3.Railway transport)
• ii) Introduction of Industrial Entrepreneurs‘
Memorandum (IEM)
01/01/2010 233
6.Industrial Policy..
• Industries not requiring compulsory licensing are to
file an Industrial Entrepreneurs‘ Memorandum (IEM)
to the Secretariat for Industrial Assistance (SIA). No
industrial approval is required for such exempted
industries. Amendments are also allowed to IEM
proposals filed after 1.7.1998.
• iii) Liberalisation of the Locational Policy
• A significantly amended locational policy in tune with
the liberalised licensing policy is in place:
• No industrial approval is required from the
Government for locations not falling within 25 kms of
the periphery of cities having a population of more
than one million except for those industries where
industrial licensing is compulsory.
01/01/2010 234
6 6.Industrial Policy..
• Non-polluting industries such as electronics,
computer software and printing can be located
within 25 kms. of the periphery of cities with
more than one million population.
• Permission to other industries is granted in such
locations only if they are located in an industrial
area so designated prior to 25.7.91. Zoning and
land use regulations as well as environmental
legislations have to be followed.
01/01/2010 235
6.Industrial Policy..
• iv) Policy for Small Scale Industries
• Reservation of items of manufacture exclusively
for the small scale sector forms an important
focus of the industrial policy as a measure of
protecting this sector. Since 24th December
1999, industrial undertakings with an investment
upto rupees one crore are within the small scale
and ancillary sector.
01/01/2010 236
6.Industrial Policy..
• A differential investment limit has been adopted
since 9th October 2001 for 41 reserved items
where the investment limit upto rupees five crs. is
prescribed for qualifying as a small scale unit.
The investment limit for tiny units is Rs. 25 lakhs.
• 749 items are reserved for manufacture in the
small scale sector. All undertakings other than
the small scale industrial undertakings engaged
in the manufacture of items reserved for
manufacture in the small scale sector are
required to obtain an industrial license and
undertake an export obligation of 50% of the
annual production.
01/01/2010 237
6.Industrial Policy..
• This condition of licensing is, however, not
applicable to those undertakings operating
under 100% Export Oriented Undertakings
Scheme, the Export Processing Zone (EPZ) or
the Special Economic Zone Schemes (SEZs).
• V) Non-Resident Indians Scheme
• The general policy and facilities for Foreign
Direct Investment as available to foreign
investors/company are fully applicable to NRIs
as well.
01/01/2010 238
6.Industrial Policy..
• In addition, Government has extended some
concessions specially for NRIs and overseas
corporate bodies having more than 60% stake by
the NRIs.
• These inter-alia includes (i) NRI/OCB investment
in the real estate and housing sectors upto 100%
and (ii) NRI/OCB investment in domestic airlines
sector upto 100%.
• NRI/OCBs are also allowed to invest upto 100%
equity on non-repatriation basis in all activities
except for a small negative list. Apart from this,
NRI/OCBs are also allowed to invest on
repatriation/non-repatriation under the portfolio
investment scheme.
01/01/2010 239
6.Industrial Policy..
• vi) Electronic Hardware Technology Park
(EHTP)/Software Technology Park (STP)
scheme
• For building up strong electronics industry and
with a view to enhancing export, two schemes
viz. Electronic Hardware Technology Park
(EHTP) and Software Technology Park (STP)
are in operation.
• Under EHTP/STP scheme, the inputs are
allowed to be procured free of duties.
01/01/2010 240
6.Industrial Policy..
• The Directors of STPs have powers to approve
fresh STP/EHTP proposals and also grant post-
approval amendment in respect of EHTP/STP
projects as have been given to the Development
Commissioners of Export Processing Zones in
the case of Export Oriented Units.
• All other applications for setting up projects
under these schemes, are considered by the
Inter-Ministerial Standing Committee (IMSC)
Chaired by Secretary (Information Technology).
The IMSC is serviced by the SIA.
01/01/2010 241
6.Industrial Policy..
• vii) Policy for Foreign Direct Investment (FDI)
• Promotion of foreign direct investment forms an
integral part of India‘s economic policies.
• The role of foreign direct investment in accelerating
economic growth is by way of infusion of capital,
technology and modern management practices.
• The Department has put in place a liberal and
transparent foreign investment regime where most
activities are opened to foreign investment on
automatic route without any limit on the extent of
foreign ownership.
01/01/2010 242
6.Industrial Policy..
Some of the recent initiatives taken to further
liberalise the FDI regime, inter-alia, include:
• opening up of sectors such as Insurance (upto
26%);
• development of integrated townships (upto
100%);
• defence industry (upto 26%);
• tea plantation (upto 100% subject to divestment
of 26% within five years of FDI);
01/01/2010 243
6.Industrial Policy..
• Enhancement of FDI limits in private sector
banking,
• allowing FDI up to 100% under the automatic
route for most manufacturing activities in SEZs;
• opening up B2B e-commerce; Internet Service
Providers (ISPs) without Gateways;
• electronic mail and voice mail to 100% foreign
investment.
FDI Restrictions
FDI up to 100% is allowed under the automatic
route in all activities/sectors except the following:
1. Sectors prohibited for FDI
2. Activities/items that require an industrial license
3. Proposals in which the foreign collaborator has
an existing financial/technical collaboration in
India in the same field
4. Proposals for acquisitions of shares in an
existing Indian company in financial service
sector and where SEBI (substantial acquisition
of shares and takeovers) regulations, 1997 is
attracted
FDI Restrictions….

5. All proposals falling outside notified sectoral
policy/CAPS under sectors in which FDI is not
permitted
6. The sectors that are not in the automatic route,
investment requires prior approval of the
Central Government. The approval in granted
by Foreign Investment Promotion Board
(FIPB).

Prohibited Industries for FDI
The extant policy does not permit FDI in the following
cases:
×Gambling and betting ×Lottery Business ×Atomic
Energy ×Retail Trading ×Agricultural or plantation
activities of Agriculture (excluding Floriculture,
Horticulture, Development of Seeds, Animal
Husbandry, Pisiculture and Cultivation of
Vegetables, Mushrooms etc., under controlled
conditions and services related to agro and allied
sectors) and Plantations (other than Tea
Plantations)
01/01/2010 247
6.Industrial Policy..
• The Department has also strengthened
investment facilitation measures through Foreign
Investment Implementation Authority (FIIA).
• Trade Policy Reforms: Most items freely
importable, quantitative restrictions lifted.
01/01/2010 248
6.Industrial Policy..
• Monetary Policy and Financial Sector Reforms:
Securitisation Act for better security for creditors;
Competition law enhanced and Competition
Commission constituted.
• Independent Regulators SEBI and IRDA in
place. Rationalisation of Tax Structure:
Reduction in peak customs tariff from 300% in
1991 to 25% in 2004;
• Special investment and tax incentives for
exports in certain sectors such as power,
software, electronics, BPO and food processing.
01/01/2010 249
6.Industrial Policy..
• Conducive foreign investment environment that
provides freedom of entry, investment, location,
choice of technology, production, repatriation of
capital, dividends etc. which are specifically aimed
at enhancing the flow of FDI.
• IPR initiatives taken : IPR laws are TRIPS
compliant; IPR appellate Tribunal functional from
2003; Digital database library of patents,
trademarks and design records.
01/01/2010 250
6.DIPP: Annual Report 2007 – 08:
• With the progressive liberalization of the Indian
economy, initiated in July 1991, there has been
a consistent expansion in the role and functions
of this Department.
• From regulation and administration of the
industrial sector, the role of this Department has
moved to facilitation of technology and
investment flows and promotion of industrial
development in the liberalized environment.
6.DIPP: Annual Report 2007 – 08…
• The role and functions of the Department of
Industrial Policy and Promotion (DIPP) primarily
include: -
• Formulation and implementation of industrial
policy and strategies for industrial development
in conformity with the developmental needs and
national objectives, in order to make the Indian
industry internationally competitive;
• Monitoring and stimulation of industrial growth in
general, and performance of industries
specifically assigned to it in particular and
guidance in the creation of an enabling
environment, infrastructure, technology transfer/
collaborations on all industrial and technical
matters;
6.DIPP: Annual Report 2007 – 08…
• Approval of foreign technology collaborations at
enterprise level and formulation of policy
parameters for the same, for enhancing
productivity, with reference to international
benchmarking;
• Formulation of Foreign Direct Investment (FDI)
Policy and amendments thereto as well as
promotion and facilitation of direct foreign and
non-resident investment in industrial and service
projects;
• Association, as nodal department, for
investment related issues in Bilateral/regional
economic Cooperation Agreements;
01/01/2010 253
6.DIPP: Annual Report 2007 – 08…:
• Formulation of policies relating to Intellectual
Property Rights in the fields of Patents,
Trademarks, Industrial Designs and
Geographical Indications of Goods and
administration of regulations and rules made
thereunder;
• Administration of Industries (Development &
Regulation) Act, 1951;
• Promotion of Industrial development of
industrially backward and remote, hilly and
inaccessible areas of the Special category
States of ……
01/01/2010 254
6.DIPP: Annual Report 2007 – 08…:
• ……North Eastern Region including Sikkim),
Jammu & Kashmir, Himachal Pradesh and
Uttarakhand through special incentive packages;
• Promotion of international cooperation through
productivity, quality and technical cooperation;
• Compilation of data/statistics on Foreign Direct
Investment & analysis thereof ; and
• Compilation of monthly industrial production
statistics for use in the construction of Index of
Industrial Production (IIP).
01/01/2010 255
6.DIPP: Annual Report 2007 – 08:
• The Department is responsible for formulation
and implementation of promotional and
developmental measures for growth of the
industrial sector, keeping in view the national
priorities and socioeconomic objectives.
• While individual Administrative Ministries look
after the production, distribution, development
and planning aspects of specific industries
allocated to them, this Department is responsible
for the overall Industrial Policy.
01/01/2010 256
6.DIPP: Annual Report 2007 – 08..:
• This Department is the nodal organization for
the promotion of productivity in the industrial
sector.
• It undertakes programmes of technical
cooperation with the Asian Productivity
Organization (APO), Tokyo, by sourcing experts
to advise on productivity related projects and by
deputing officials from the private and public
sector to programmes conducted by the APO in
industry, agriculture and service related sectors.
01/01/2010 257
6.DIPP: Annual Report 2007 – 08…:
• It also promotes the adoption of quality
standards relating to the ISO 9000/14000 series
through the accreditation services provided by
National Boards for Certifying Bodies and
Auditors and Trainers under the Quality Council
of India, which has been certified by
international accreditation bodies.
• Schemes For Industrial and Infrastructure
Development:
01/01/2010 258
6.DIPP: Annual Report 2007 – 08..:
• This Department administers the Industrial
Infrastructure Upgradation Scheme (IIUS) for
enhancing the competitiveness of the domestic
industry by providing quality infrastructure
through public-private partnership in selected
functional clusters. Central assistance up to 75%
of the project cost subject to a maximum of Rs.
50 crs. is provided under the Scheme
• FDI Promotion Initiatives : Several steps have
been initiated to facilitate increased FDI inflows
which include, inter-alia, the following:
01/01/2010 259
6.DIPP: Annual Report 2007 – 08:
• (a) On the policy front, while our FDI policy is
already very liberal, the policy is being further
progressively rationalised.
• (b) On the investment promotion front, the
Department organises Destination India events
in association with CII and FICCI.
• (c) The Foreign Investment Implementation
Authority (FIIA) has been activated towards
speedy resolution of investment related
problems.
01/01/2010 260
6.DIPP: Annual Report 2007 – 08:
• (d) National Manufacturing Competitiveness
Council has been set up to provide a continuing
forum for policy dialogue to energise and sustain
the growth of manufacturing industries.
• (e) The Department has regular interaction with
foreign investors. Such interactions have been
held in bilateral/ regional/ international meets
such as Indo- ASEAN, Indo-EU, Indo-Japan, etc.
Meetings with individual investors were also held
on a regular basis.
01/01/2010 261
6.DIPP: Annual Report 2007 – 08:
• (f) The Department website ( www.dipp.nic.in ) has
been made both comprehensive and informative
with online chat facility. About 4500 investment
related queries were replied during the year.
• Investment Climate : The advantages of India as
an investment destination rest on strong
fundamentals which include:
•  a large and growing market;  world-class
scientific, technical and managerial manpower; 
cost effective and highly skilled labour;
abundant natural resources; a large English
speaking population and an independent
judiciary etc.
01/01/2010 262
6.DIPP: Annual Report 2007 – 08:
• This is now recognised by a number of global
investors who have either already established a
base in India or are in the process of doing so.
• Ongoing initiatives, such as further simplification
of rules and regulations and improvement in
infrastructure are expected to provide necessary
impetus to increase FDI inflows in future. .

01/01/2010 263
6.DIPP: Annual Report 2007 – 08:
• All the State Governments offer some or the
other incentives to Industrialists to induce them
to invest in their states – so that the economy of
the state can grow at the needed pace.
• Rehabilitation and resettlement policy and
associated legislative measures relating to land
acquisition : (Press Information Bureau ,
Government of India, 11/10/2007):
01/01/2010 264
6.Rehabilitation and Resettlement Policy:

• The new Policy and the associated legislative
measures aim at striking a balance between the
need for land for developmental activities and, at
the same time, protecting the interests of the
land owners, and others, such as the tenants,
the landless, the agricultural and non-agricultural
labourers, artisans, and others whose livelihood
depends on the land involved.
01/01/2010 265
6.Rehabilitation and Resettlement Policy:
• The benefits under the new Policy shall be
available to all affected persons and families
whose land, property or livelihood is adversely
affected by land acquisition or by involuntary
displacement of a permanent nature due to any
other reason, such as natural calamities, etc.
• The Policy will be applicable to all these cases
irrespective of the number of people involved.
01/01/2010 266
6.Rehabilitation and Resettlement Policy:
• The benefits to be offered under the new Policy
to the affected families include; land-for-land, to
the extent Government land would be available
in the resettlement areas;
• preference for employment in the project to at
least one person from each nuclear family within
the definition of the ‗affected family‘, subject to
the availability of vacancies and suitability of the
affected person;
01/01/2010 267
6.Rehabilitation and Resettlement Policy:
• training and capacity building for taking up
suitable jobs and for self-employment;
• scholarships for education of the eligible persons
from the affected families;
• preference to groups of cooperatives of the
affected persons in the allotment of contracts and
other economic opportunities in or around the
project site;
• wage employment to the willing affected persons
in the construction work in the project;
• housing benefits including houses to the landless
affected families in both rural and urban areas;
and other benefits.
01/01/2010 268
Industrial Park Scheme, 2002:
• Objectives of the industrial park: setting up of
×an Industrial Model Town for development of
industrial infrastructure for carrying out
integrated manufacturing activities including
research and development
×an industrial park for development of
infrastructural facilities or built-up space with
common facilities
×the Growth Centre is distinctly developed as a
separate profit centre.
01/01/2010 269
6.National Design Policy:
• FDI Policy: See the detailed chart in the notes:
• National Design policy: Objectives:
×preparation of a platform for creative design
development, design promotion and
partnerships
×presentation of Indian designs and innovations
on the international arena
×attracting investments, including foreign direct
investments, in design services and design
related R & D;
01/01/2010 270
6.National Design Policy:
×global positioning and branding of Indian
designs
×well defined and managed regulatory,
promotional and institutional framework raising
Indian design education to global standards of
excellence.
×making India a major hub for exports and
outsourcing of designs and
×creation of awareness among manufacturers
and service providers, particularly SMEs and
cottage industries
01/01/2010 271
6.National Design Policy:
• Action plan :
×Setting up of specialised Design Centres or
―Innovation Hubs‖ for sectors such as
automobile and transportation, Jewellery,
leather, soft goods, electronics / IT hardware
products, toys & games which will provide
common facilities and enabling tools like rapid
product development, high performance
visualisation, etc.
×Formulation of a scheme for setting up Design
Centres/Innovation Hubs
01/01/2010 272
6.National Design Policy:
×Preparation of a mechanism for recognising and
awarding industry achievers in creating a brand
image
×Encouraging Indian firms and institutions to
develop strategic alliances with design firms and
institutions abroad to gain access to technology
and know-how improving Indian design.
×four more National institutes of Design on the
pattern of NID will be set up in different regions
of the country
01/01/2010 273
6.National Design Policy:
×Encouraging the teaching of design in vocational
institutes oriented to the needs of Indian industry
×Organising workshops and seminars
×encourage and facilitating a culture for creating
and protecting intellectual property in the area of
designs


01/01/2010 274
6.Ultra mega power project (UMPP):
×These are very large sized projects,
approximately 4000 MW each involving an
estimated investment of about Rs. 16,000 crore.
×Five coastal sites at:- Mundra in Gujarat,
Krishnapatnam in Andhra Pradesh, Tadri in
Karnataka, Girye in Maharashtra, and Cheyyur
in Tamil Nadu.
×Four pithead sites at :- Sasan in Madhya
Pradesh, Tilaiya in Jharkhand, Sundergarh
District in Orissa and Akaltara in Chhattisgarh.
01/01/2010 275
6.Now some of the States:
• North East Industrial and Investment Promotion
Policy (NEIIPP), 2007:
× The North East Industrial Policy (NEIP), 1997
announced on 24.12.1997 covered the States of
Arunachal Pradesh, Assam, Manipur,
Meghalaya, Mizoram, Nagaland and Tripura.
× Under NEIIPP, 2007, Sikkim will also be
included.
× Duration of incentives: All new units as well as
existing units which go in for substantial
expansion,will be eligible for incentives for a
period of ten years from the date of
commencement of commercial production.
01/01/2010 276
6.NEIIPP
× Excise duty exemption: 100% Excise Duty
exemption
× Income Tax Exemption: 100% Income Tax
exemption
× Interest Subsidy: Interest Subsidy will be made
available @ 3% on working capital loan
× Incentives for Service/other Sector Industries : A
number of tax concessions:
• Capital Investment Subsidy: Capital Investment
Subsidy will be enhanced from 15% of the
investment in plant and machinery to 30%
01/01/2010 277
6.NEIIPP
• the limit for automatic approval of subsidy at this
rate will be Rs.1.5 crores per unit, as against
Rs.30 lakhs as was available under NEIP, 1997.
• Incentives for Bio-technology industry:
• The biotechnology industry will be eligible for
benefits under NEIIPP, 2007 as applicable to other
industries.
• Incentives for Power Generating Industries:
• Power Generating plants will continue to get
incentives as governed by the provisions of the
Income tax Act.
01/01/2010 278
6.NEIIPP
• Industries Not Eligible:
• tobacco and manufactured tobacco substitutes.
• Pan Masala
• Plastic carry bags of less than 20 microns
• Goods produced by petroleum oil or gas
refineries.
• Transport Subsidy Scheme -2007:
• It covers all North eastern region
01/01/2010 279
6.NEIIPP
• Transport subsidy is paid on the transport cost of
raw material brought into and finished goods
which are taken out.
• It is available at the rate of 90% within north
eastern region and at the rate of 50%for finished
good from this region to other region.
• Centre gives various financial assistance limited
to one-third of total cost of infrastructural
development
01/01/2010 280
6.Maharashtra….Incentives:
• Ranks first among the states in terms of State
domestic production accounts for 15% of the
national income
• Per capita income of Rs.23,849, more than 60%
higher than the national average
• Contributes 22% in organised industrial sector
• 40% of internet users are from Maharashtra
• 30% of software export
• Well set mechanism to support industry
01/01/2010 281
6.Maharashtra….Incentives:
• Highest power generation capacity, at more than
14000MW
• More than 215 industrial estates, including 9 five
star industrial estate and 63 growth centers
• 301 engineering degree/ diploma colleges
• ITI‘s with turnout of 160000 technocrats every
year
• Literacy rate at 75%

01/01/2010 282
6.Maharashtra :Policies and Incentives
• A) New Micro & Small Manufacturing
Enterprises, Medium Enterprises / LSI (including
IT/ BT units)
• B) Interest subsidy:
All new eligible Micro & Small Manufacturing
Enterprises in textile, hosiery, knitwear and
readymade garment sector will be eligible for
interest subsidy in addition to Industrial
Promotion Subsidy.
(See the Tables for A and B in the Notes)
01/01/2010 283
6.Maharashtra :Policies and Incentives
• C) Exemption from Electricity Duty:
• 100% Export Oriented Units (EOUs), Information
Technology (IT) and Bio-Technology (BT) units will
also be exempted from payment of Electricity Duty
for a period of 10 years.
• D) Waiver of Stamp Duty:
• C, D, D+ Talukas and No Industry Districts –
Exempted
• A and B areas:
• BT and IT units in public Parks : 100%
• BT and IT units in private Parks : 75%
• Mega Projects : 50%
01/01/2010 284
6.Gujarat

• 5 per cent of the India‘s total population
• 6 per cent of geographical area
• Gujarat contributes to 16 per cent of the
country‘s total investment
• 10 per cent of expenditure
• 16 per cent of exports
• 30 per cent of stock market capitalization
• The state‘s annual growth rate has been 10
to 12 per cent for the last five years.
• As per the latest data of Centre for Monitoring
Indian Economy (CMIE) of January 2003,
Gujarat stands first in industrialization in
India.

01/01/2010 285
6.Gujarat

• Projects worth Rs. 33,958 crore are under
implementation.
• Gujarat‘s State Domestic Product (SDP) rising at
an average growth rate of 12.4% per annum
• Gujarat achieved as much as 35% of
augmentation in its power generation capacity
• Three LNG terminals to come up.
• one of the first few states in India to have
encouraged private sector investment in the
infrastructure.
01/01/2010 286
6.Gujarat

• Gujarat accounts for almost 21% share in the
export basket of India.
• Longest coastline of 1600 kms, dotted with 41
ports, 1 major, 11 intermediate and 29 minor
ports.
• Excellent road network – exceeding 74000 kms.
• Highest number of Airports in India – 11
including an international airport in Ahmedabad.
• An extensive rail network connecting all major
centers in the state.
01/01/2010 287
6.Gujarat

• Largest producer of Salt and Soda Ash in the
country.
• Largest grass-root Petroleum Refinery in the
world operational at Jamnagar.
• Industrial Policy 2003 •Growth Policy
• Power Policy • Tourism Policy • Road Policy •
Port Policy • Mineral Policy 2003
•IT Policy 2006 – 2011 •BT Policy 2007 - 2012
•Disaster Management Policy
01/01/2010 288
6.GUJARAT INDUSTRIAL POLICY - 2000
(Growth Policy)
• Aims to achieve sustainable industrial
development
×Makes the State more attractive to accelerate
further the flow of investment
×Proposes to promote IT and knowledge based
industries
×Enhanced exports from industrial units targeted
×Encourages the development of small scale
industries and service sector industries
01/01/2010 289
GUJARAT INDUSTRIAL POLICY - 2000
(Growth Policy)
×Promotes industries in backward areas
× Assistance for activities like market
development and promotion
× Upgradation of entrepreneurial skill of first
generation entrepreneurs
×Asset management fund introduced to cover
debt and equity fund for financial assistance to
infrastructure projects
×Encourages setting up of private sector industrial
parks
01/01/2010 290
6.Schemes under Gujarat Industrial
Policy - 2000

×Interest Subsidy or State cash subsidy to Small
Scale Industries
×Scheme of Interest Subsidy to Service Sector
Industries
× Industrial Park Scheme - 2000
×Incentive Scheme for Export Oriented Park and
Export Oriented Units
×Insertion of additional items of production in the
Sale Tax Eligibility Certificate
×Medium and Large Industries - Subsidy Scheme
2000
01/01/2010 291
6.Gujarat Industrial Policy – 2000,.. Power
Policy:
×Assistance for Research & Development and
Patent Registration
× Amendment in Financial Assistance for
upgradation of quality in SSI/ Medium & Large
Scale Sector
×Declaration of Backward Talukas eligible for
benefits
• POWER POLICY (HIGHLIGHTS)
×building up adequate capacity in generation,
transmission and distribution
01/01/2010 292
6.Gujarat Industrial Policy – 2000,.. Power
Policy:
×Achieving optimum utilisation of existing
equipments
×Rationalizing the tariff structure
×Improving quality of services thereby achieving
cost effectiveness
×Striving for energy conservation
×Encouraging power generation utilising non-
conventional sources
01/01/2010 293
6.PORT POLICY --HIGHLIGHTS
• Enhancing Gujarat‘s Share in EXIM Sector
• Decongesting the overburden on existing ports
• Developing / upgrading port facilities at 10
locations.
• Providing port facilities to promote export-
oriented industries and port-based industries
entailing almost 50% of total industrial
investment.
• Encouraging shipbuilding, ship repairing and
manufacturing facilities
01/01/2010 294
6.PORT POLICY --HIGHLIGHTS
• Promoting coastal shipping for passengers and
cargo traffic between various locations within
and outside of the state.
• Supporting power plants by offering exclusive
facilities for import of different power fuels.
• Attracting private sector investment in minor and
intermediate ports as also at the new port
locations.
01/01/2010 295
6.IT Policy 2006 – 2011

• Capital Incentive Subsidy:
New IT unit will be entitled to avail capital
subsidy @25% of eligible total capital
investment or Rs.25 lakhs whichever is less.
• Special Incentives:
There will be Special Incentives scheme for the
projects with large capital base.
• Turnover incentives:
• Connectivity incentives:
01/01/2010 296
6.Tamilnadu:

• One of the top three recipients of Foreign
Direct Investment (FDI).
• Ranks No.1 in availability of skilled manpower
in India.
• Low cost of Man power. Lower cost of living.
• Largest tour-out of Engineers Technicians
(1,30,000 from a network of 252 Engineering
Colleges & 210 Polytechnics).
• Tamilnadu has 3 major Ports: Chennai
Ennore and Tuticorine with twin port
advantage at Chennai and Ennore apart from
14 minor Ports.
01/01/2010 297
6.Tamilnadu:

• 270 passenger flight and 28 cargo flights per
week at Chennai Airport-The Largest in South
India.
• A total road network of 150,000 kms.
• The only Power surplus state in India.
• Prompt allotment of land in the industrial parks
with supporting infrastructure.
• Single window facilitation to complete pre-
project documentation.
01/01/2010 298
6.Tamilnadu:

• Power and water supply, access roads and other
supporting infrastructure.
• Incentive Schemes
• Most Backward Areas
• Backward Areas
• Electronic Industries
• Leather Industries
• Floriculture Units
• Selected Category of Industries
• Mega projects
01/01/2010 299
6.Tamilnadu:

• Effluent Treatment Plants
• Purchase of Generators
• Employing Women Workers
• Subsidy for Most Backward Areas : subsidy of
20% of fixed assets with a ceiling of rs. 20 lakhs
• Subsidy For Backward Areas: A Capital Subsidy
of 15% on eligible fixed assets subject to a
ceiling of Rs.15 lakhs
• Special Subsidy for Electronic Industries :
20% on eligible fixed assets subject to a ceiling
of RS.20 lakhs.
01/01/2010 300
6.Tamilnadu:

• Special Subsidy for Leather Industries :
a Special SUBSIDY of 20% on eligible fixed
assets subject to a ceiling of RS.20.00 lakhs.
• Additional Subsidy for Employing Women
Workers :
New Industrial units ( small, medium or major)
where more than 30% of the total workers
employed are women shall be eligible for an
additional Capital Subsdiy of 5% of investment in
eligible fixed assets subject to a ceiling of Rs.5
lakhs.
01/01/2010 301
6.Tamilnadu:

• Subsidy for Floriculture Units :capital subsidy of
20% on eligible fixed assets subject to a ceiling
of Rs.20.00 lakhs.
• Generator subsidy for certain industry: 15% of
cost of generator subject to maximum of rs
15lakhs.
• Special Subsidy For Selected Category of
Industries
01/01/2010 302
6.Tamilnadu:

• A Special Subsidy of 10% on eligible fixed
assets, a ceiling of Rs.15 lakhs
• i) Automobile Spare Parts.
• ii) Drugs and Pharmaceuticals.
iii) Solar Energy Equipment and non
conventional energy devices.
iv) Export oriented Gold jewellery making and
Diamond processing v) Pollution Control
Equipments
vi) Jute Industry
vii) Sports goods and accessories
viii) Food Processing Industry
01/01/2010 303
6. Legal aspects of Project Management:
• Legal aspects of Project Management:
• The Project team should have a fundamental
understanding of the legal statutes which
regulate their work. In the normal course of
Project execution.
• Regulations are the basis for steady growth
• They govern that everything occurs in conformity
with plans & policy adopted
01/01/2010 304
6. Legal aspects of Project Management:
• They are the process by which we check
whether or not:
×plans are being adhered to × Environment is
safe from pollution × Law & order is maintained
t
• × Any deviations for which a corrective actions
needs to be taken
• The Project Team is expected to be conversant
with the following acts:
• The Indian Contract Act;
• State industries act
01/01/2010 305
6. The Acts:
• The factories act, 1948
• Income tax act, 1981
• Central sales tax & state sales tax acts
• The Sale of Goods Act;
• Acts relating to Life and General Insurance;
• The Insolvency Act;
• The Negotiable Instruments Act;
• The Laws relating to Transports _Carriage of
Goods Act;
• The laws relating to Sales Tax, Central
Excise and Customs;
01/01/2010 306
6. The Acts:
• The Foreign Exchange Management Act (FEMA);
• Major Port Trust Act;
• Transfer of Property Act;
• The laws relating to mortgages;
• The laws relating to land acquisition and Land
Disputes; Land Ceiling Act;
• Labour Legislations –Payment of wages act, 1936;
Minimum wages act, 1948; Employees Providend
Fund Act, 1952; Pension Funds/Gratuity;
Employees State Insurance Act, 1948; Industrial
Disputes Act,
01/01/2010 307
6. The Acts:
• Legislations concerning Environmental Pollution;
• The Companies Act;
• And many more which are relevant to the
activities that are undertaken in the execution of
the Project.
+The most important of all is the Contract Act,
which pervades or touches upon every
business activity.
01/01/2010 308
6. Contract Act
• Some of the situations arising out of contracts
are more specifically dealt in other Acts – like
the Sale of Goods Act, Transfer of Property Act.
Etc.
• Hence a thorough understanding of the
Contract Act is a must for a Project Manager.
+Law of Agency: The Project Manager should
remember that he is an Agent of the owners of
the Project and is answerable to them for his
actions even when they are bona-fide.
01/01/2010 309
6. Contract Act
• An agent cannot do what the principal himself
cannot do.
• In case of emergencies, the Project Manager (
as the agent) has the authority to do every
lawful thing necessary for the purpose of
protecting his principal from loss, as would be
done by a person of ordinary prudence would
do to protect his interests in similar
circumstances.

01/01/2010 310
6. Contract Act –IDR Act
• When an Agent does more than what he is
authorised to do, and if the unauthorised acts of
the agent can be separated from the authorised
acts, then the Agent is liable for the
consequences of the unauthorised acts.
+Industries Development and Regulation Act :
• The Act Provides The Conceptual And Legal
Framework For Industrial Development And
Industries In India
01/01/2010 311
6. The IDR Act
• The Licensing Policy For Industries Is
Determined Under This Act.
• The Act Specifies The General Requirements
That Are To Be Complied With By Small-scale
Units.
• ----Investment of unit in fixed assets
--Nature of ownership:
--Smallness of number of workers employed
--Nature, cost and quality of product etc
• Section 29-B provides reservation of products
for exclusive production in the small-scale
sector.
01/01/2010 312
6. The IDR Act
• The Act specifically refers to only two categories
of the small-scale sector: -
-Small Scale Industrial undertaking
- Ancillary Industrial Undertaking
• It is capable enough of meeting the consumer
goods needs of the community
• The government should keep the interest of
community at uppermost in time
• Provide a support from large houses &
safeguard the interest of millions of those who
depend on it for their livelihood.
01/01/2010 313
6.The Factories Act, 1948

• The Factories Act is the principal legislation,
which governs the health, safety, and welfare of
workers in factories.
• A factory under the Act is defined as a place
using power, employs 10 or more workers, or 20
or more workers without power or were working
any day of the preceding 12 months
01/01/2010 314
6.The Factories Act, 1948

• Electronic Data Processing Unit or a Computer
Unit is installed shall not be considered at a
factory if no manufacturing process is being
carried on in such premises.
• The Act does not permit the employment of
women and young in a dangerous process or
operation.
• Section 11 to 20 deal with various provisions
such as:
• Environmental sanitation that protect the worker
from hazardous environment.
01/01/2010 315
6.The Factories Act, 1948

• Cleanliness of the working place, privy, benches,
stairs, wall etc. are explained
• Disposal of wastes and effluents should be
without any risk
• Ventilation, temperature inside factory, dust and
fumes emission, lighting, artificial humidification,
overcrowding (minimum of 50 cubic meters per
person) are specified
• Safety measures like fencing of machines,
protection of eyes against fire, dangerous fumes,
etc. are defined
01/01/2010 316
6.The Factories Act, 1948

• Facilities for sitting, canteens, first aid
appliances are provided.
• There is provision for one weekly holiday, and
not more than 48 hours of working in a week.
+Payment of Wages Act, 1936
• It has been enacted to regulate the payment of
wages to workers employed in certain specified
industries and to ensure a speedy and effective
remedy to them against illegal deductions or
unjustified delay caused in paying wages to
them.
01/01/2010 317
6.The Factories Act, 1948

• It applies to the persons employed in a factory,
industrial or other establishment or in a railway
• The act is applicable to employees drawing
wages upto Rs. 1600/- a month.
• The person responsible for payment of wages
shall fix the wage period upto which wage
payment is to be made.
• All wages shall be paid in current legal tender,
i.e in current coin or currency notes or both.

01/01/2010 318
6.The Factories Act, 1948

• All payment of wages shall be made on a
working day.
• Although the wages of an employed person
shall be paid to him without deductions the act
allows deductions from the wages of an
employee on the account of the following:-
• ·fines ·Absence from duty ·Damage to or
loss of goods by the employee · Housing
accommodation and amenities provided by the
employer · Recovery of advances or
adjustment of over-payments of wages ·
Recovery of loans made from any fund
01/01/2010 319
6.The Factories Act, 1948

• Hence, The Main Objective Of The Act Is To:
• Eliminate All Malpractices
• By Laying Down The Time And Mode Of
Payment Of Wages
• Securing That The Workers Are Paid Their
Wages At Regular Intervals, Without Any
Unauthorized Deductions
01/01/2010 320
6.Labour Laws:
+Labour Laws: This is probably the most
important and sensitive issue in Project
Management.
×So many issues like payment of proper wages at
the proper time, handling of disputes, strikes,
severance packages, remittance of dues to the
Govt. towards Employees State Insurance,
Providend/ Pension contributions to the
Providend Commissioner‘s Office within the
stipulated time schedule etc. come under this
section.
01/01/2010 321
6.Labour Laws:
×So, the Project Manager has to take care to see
that his team members handle such items
carefully.
+Employees' Provident Fund and Act, 1952
• The main objective of making some provisions
for the future of industrial workers after their
retirement and for their dependents in case of
death.
• It provides insurance to workers and their
dependents against risks of old age, retirement,
discharge, retrenchment or death of the workers.
01/01/2010 322
6.Labour Laws:
• The Act is administered by the Government of
India through the Employees' Provident Fund
Organization (EPFO
• Three Schemes Are In Operation Under The
Act:
• Employees' Provident Fund Scheme, 1952
• Employees' Deposit Linked Insurance Scheme,
1976
• Employees' Pension Scheme, 1995 (Replacing
The Employees' Family Pension Scheme, 1971)
01/01/2010 323
6.Labour Laws:
• To provide the employees an old age and
survivorship benefits
• A long term protection and security to the
employee and after his death to his family
members
• Timely advances including advances during
sickness and for the purchase/ construction of A
dwelling house during the period of membership.
01/01/2010 324
6. Sales of Goods Act
+Sale of Goods Act: Sale contract is a bilateral
contract with money consideration being a must
for the sale of goods and the exact moment
when the title passes on to the buyer from the
seller defined clearly in the Act.





01/01/2010 325
6. Sales of Goods Act
• The Project Manager and his team should know
the intricacies of this act as they may have to
face many tricky situations – for example, the
seller might not have delivered the goods as
agreed as per time, quantity or quality etc. or the
Project Finance Department might not have
made the agreed payment in full.
• Any of these may cause a delay in use of the
goods in question affecting the time schedule of
the project.
01/01/2010 326
6. Sales of Goods Act
+Central Sales Tax Act: Most of the states have
agreed to change over to the ‗VAT‘ system.
There are differing Tax laws governing sale of
goods within a state (State Sales Tax Acts) and
from a place in one state to a place in another
State (CST) and now the VAT.
· The Project Manager and his team should be
aware of the consequences of not loading the
appropriate tax amount in the goods
purchased for the project as any subsequent
claim by the seller of the goods or the Tax
authorities would inflate the cost of the project.
01/01/2010 327
6. Carriages of Goods Act
+Carriage of Goods Act: A contract of carriage of
goods is a contract entered into between
parties for transportation of goods from the point
of dispatch to the point of destination. Since the
goods meant for the project have to be
transported the Project Manager has to be
aware of the implications of the duties and
responsibilities of the sending and the receiving
parties.
01/01/2010 328
6. Foreign Exchange Management Act
(FEMA)
+Foreign Exchange Management Act (FEMA):
When goods are exported or imported or any
payments are remitted abroad towards royalty
or fees paid for technical drawings/designs, or
for the foreign architects/technicians towards
their compensation, FEMA comes into picture
and care has to be taken to see that there are
no violations.
+Here the Bankers who deal with such
transactions will guide the Project Manager
properly. But part of the responsibility falls on
the customer also.
01/01/2010 329
6. Negotiable Instruments act (NI Act)
+Negotiable Instruments Act: This deals with the
Negotiable instruments – Promissory Notes, Bills
of Exchange, Cheques and Drafts.
• The makers, payees, endorsers and endorsees
all have their rights and responsibilities and
hence the Project Manager and his team should
be fully aware of these nuances and act carefully
while handling the Negotiable Instruments.

01/01/2010 330
6. Legal aspects of Project Management:
+Bailment, Indemnity : These are coming out of
contracts and separately elaborated. Bailment is
delivery of goods by one person to another for
some purpose like safe keeping etc. The bailer
and the bailee have their own rights and
responsibilities.
• The contract of Indemnity is defined as a contract
between the promisor called the Indemnifier and
the promisee called the indemnified whereby the
former undertakes the responsibility of
compensating any loss that the latter may suffer
due to his own conduct or due to conduct of
some one else. It is essentially a contingent
contract.
01/01/2010 331
6. Legal aspects of Project Management:
+The Excise Act: Excise is an indirect tax and
is paid by the seller to the government before
sending out the goods out of the factory
premises and recovered from the buyer along
with the price of goods.
· Any goods which is sold directly from the
factory premises, should always accompany
the ‗Excise Gate Pass‘ while on the move
signifying the fact that the excise dues have
been paid to the Govt.
· Otherwise the Excise dept. has the powers to
seize the goods . Such incidents will
invariably delay the project execution.
01/01/2010 332
6. Legal aspects of Project Management:
+Octroi Duties: These are levied by many
Panchayats/ Municipalities/Corporations when
goods of value enter their territory – except for
the goods which are in transit through their
territory or those which are being transported to
the ports/rail heads.
· Clearing the goods in Octroi check posts is a
time consuming process and so the Project
Management should make allowance for these
delays in their project schedule.

01/01/2010 333
6. Legal aspects of Project Management:
+Acts relating to Insurance: When the goods
meant for the project are on the move or stored
there are chances of damage and hence care
has to be taken to see that the goods are
covered by insurance for the value of the goods
with the appropriate clauses or riders so as to
minimise the losses.
· Similarly when unfortunately any of the project
employees die while on duty,……
01/01/2010 334
6. Legal aspects of Project Management:
• …the heavy financial compensation that may
have to be paid to the family of the deceased
may be shared with a Life Insurance company
through ‗Group Life Insurance Policies‘ which
will cover all the employees.
01/01/2010 335
7.Financial analysis-Profitability
Analysis.
• Financial analysis refers to the process of
obtaining relevant economic information about a
project in order to establish its financial viability.
It is undertaken as one of the feasibility analyses
in project formulation.
• Financial analysis can be defined as the
process of discovering economic facts about
an enterprise and or a project on the basis of
an interpretation of financial data. It also
looks at the capital cost, operations cost and
operating revenue.
01/01/2010 336
7.Financial analysis-Profitability
Analysis.
• Most of the data required for financial analysis are
obtained from market analysis, technical analysis
and cost analysis.
• Then the data is converted and presented in the
form of Proforma Balance
Sheet, Proforma Operating Statement and Cash
Flow statements.
• Financial analysis primarily deals with the
interpretation of the financial data incorporated in
the Proforma financial statements and the
presentation of the economic facts in such a form as
to make a comparative evaluation/appraisal of
projects.

01/01/2010 337
7.Financial analysis-Profitability
Analysis.
• Financial analysis can provide insight into two
important areas of management – Return on
Investment and soundness of the company‘s
financial position.
• A financial analysis reveals where the company
stands with respect to profitability, liquidity,
leverage and an efficient use of its assets.
01/01/2010 338
7.Financial analysis-Profitability
Analysis.
• In order to complete the financial profile of a
project, it is also necessary to evaluate the
operational strategy and the investment strategy
of the project. The break even analysis is used
to explain its operational characteristics.
• The financial strategy is evaluated in terms of
financial leverage.
01/01/2010 339
7.Financial analysis-Profitability
Analysis.
• The parties who have a stake in the financial
results of a company are:  Creditors
Potential suppliers debenture holders
credit institutions like banks industrial
finance corporations potential investors
employees trade unions important
customers economists  investment analysts
taxation authorities Govts. et al. They all
look at the financial statements from different
angles.
01/01/2010 340
7.Financial analysis-Profitability
Analysis.
• The principal financial tools that are relevant in this
context are: trend analysis variable analysis
Ratio analysis Funds Flow analysis Break -
even analysis Common size analysis Cash
Budgets
• Investment criteria: NPV; Benefit Cost Ratio; IRR;
Pay Back period; Accounting Rate of Return.
• The NPV of a project is the sum of the present
values of all the cash flows-- positive as well as
negative—that are expected to occur over the life
of the project:
01/01/2010 341
NPV
• The general formula for NPV is:
n
NPV =  C
t
t =1 ----------- - initial investment
(1 +r)
t
--where C
t
= cash flow at the end of year t; n = life
of the project in years; and r = discount rate.

• (See an example in the text book – PC 8.2 to8.9 -
and do some homework assuming some figures)
01/01/2010 342
NPV
• The NPV represents the net benefit over and
above the compensation for time and risk.
• Hence the decision rule associated with the NPV
criterion is :
--Accept the project if the NPV is +ve and
--Reject if the NPV is –ve.
(If NPV is 0, then the result is indifferent i.e. the
selection of the project has to depend on other
factors, since the project is neither a profitable
nor a losing proposition)
01/01/2010 343
NPV
Properties of the NPV Rule:
• Value of a firm
=  PV of existing projects +  NPV of future
projects
• When a firm terminates an existing project which
has a negative value, the firm‘s value increases
by that amount.
• On the same lines, if a new project with an
expected negative NPV is undertaken, the
value of the firm decreases by the same amount.
01/01/2010 344
NPV
• When a firm divests an existing project, the
value of the firm increases or decreases as the
case may be by the same amount of positive or
negative difference of the price received over
the expected NPV.
• Conversely when a firm acquires an existing
project, its value will increase or decrease as the
case may be by the same amount of negative or
positive difference of the price paid over the
expected NPV;
01/01/2010 345
NPV
• Even if a firm takes up new projects with positive
NPV, the value of the firm may decrease if it falls
below the expectations of the investors.
• The NPV rule assumes that the cash flows
that occur in between the initial outflow and
the termination of the project are reinvested
at the cost of capital.



01/01/2010 346
NPV
• Different discount rates for different periods
may also be used in which case, the formula
seen earlier has to be slightly amended as
follows:
n
NPV =  C
t
t =1 ----------- - initial investment
(1 +r
t
)
t
where Ct = cash flow at the end of year t; n =
life of the project in years; and r
t
= discount
rate for the year t.
01/01/2010 347
NPV
• This formula can again be further refined as
follows:
n
NPV =  C
t
t =1 ----------- - initial investment
t
 (1 +r
j
)
t
j = 1
where C
t
= cash flow at the end of year t; n = life
of the project in years; and r
j
= one period
discount rate.
(Can you explain this concept ?)
See the textbook – PC 8.2 to 8.9 - for an
example worked out with this formula.
01/01/2010 348
NPV
• The discount rate may change over time due
to the reasons that :
the change in the level of interest rates over
time,
the risk characteristics of the project may
change over time resulting in the change in
the cost of capital;
the financing mix of the project may undergo
change over time resulting in the changes in
the cost of capital.
· NPV of a project decreases as the discount
increases.
01/01/2010 349
Modified NPV
• Modified NPV: This is another method of
finding the NPV, when the intermediate cash
flows are reinvested at a rate different from
the cost of capital and is slightly complicated
than the earlier method.
• The steps are as follows: First calculate the
Terminal Value (TV) of the project‘s cash
flows using the project‘s defined
reinvestment rate which is expected to reflect
the profitability of the investment
opportunities in the years to come.
01/01/2010 350
Modified NPV
• TV =  (t = 1 to n) CF
t
(1+r‘)
n-t
Where TV = terminal value (i.e. future value) of
the project‘s cash flows;
- CF
t
= Cash Flow at the end of year t;
- r‘ = reinvestment rate applicable to the cash
inflows of the project.
• Next determine the Modified NPV using the
formula:
• NPV* = {TV/(1+r)
n
}

- I , where NPV* =
Modified NPV; TV = Terminal Value ; r= cost
of capital and I = Investment outlay.
01/01/2010 351
Modified NPV
• See an example in the text book –PC 8.8 to 8.9.
• Limitations of NPV method:
It ignores the relative terms and the scale of
investment but gives the absolute terms ;
the life of the project is ignored ( If two projects
with different lives return the same absolute
NPV, it implies that the method favours the one
with longer life).
01/01/2010 352
Benefit Cost Method:
• Benefit Cost Method: Two methods are adopted:
• B-C Ratio : BCR = PVB/I and
• Net BCR = NBCR = (PVB-I)/I = BCR – 1.


The decision rules are:
When BCR or NBCR Rule is :
>1 >0 Accept
=1 = 0 Indifferent
<1 < 0 Reject
01/01/2010 353
Benefit Cost Method:
• Both the methods indicate the same direction
• Since the criterion measures the NPV PER RUPEE
INVESTED, it can discriminate between small and
big projects and short and long term projects and
so better than the NPV criterion.
• The draw back is that it provides no means for
aggregating several small projects into a package
to compare with a larger project. Also when there
are cash outflows beyond the current period, it is
unsuitable.
01/01/2010 354
Internal Rate of Return (IRR):
• Internal Rate of Return (IRR): .
• The IRR of a project is the discount rate which
makes its NPV = 0.
• In other words, is the discount rate which
equates the present value of future cash flows
with the initial investment. It is the value of ‗r‘
in the following equation:
• Investment =  (t = 1 to n) C
t
/(1+r)
t
• Where C
t
= cash flow at the end of year t;
r = IRR and n = life of the project.
01/01/2010 355
Internal Rate of Return (IRR):
• In the following example, where the cash flows
are:
-1,00,000, 30,000, 30,000, 40,000 and 45,000,
the IRR is the value of r which satisfies the
equation:
Rs. 1,00,000 = Rs.30000/1+r) + 30000/(1+r)
2

+ 40000/(1+r)
3
+ 45000/(1+r)
4
01/01/2010 356
Internal Rate of Return (IRR):
• The calculation of r involves a process of trial
and error.
• At 15%, the NPV = Rs.1,00,802 and at 16%, it is
98,641.
• By interpolation it is found to be 15.37%. (Excel
has a ready formula for calculating the IRR
which is widely used)
• The Decision Rule is :
Accept if the IRR is > cost of capital and
Reject if the IRR is < the cost of capital
01/01/2010 357
NPV and IRR
Comparison of NPV and IRR:
• To find the linkage between the two, let us plot
the NPV on the Y axis and the rate of return on
the x axis.
• The IRR is the point at which the NPV profile
crosses the x axis and the slope of the NPV
profile reflects how sensitive the project is to
discount rate changes.
01/01/2010 358
NPV and IRR

NPV
45000






Discount rate

15



01/01/2010 359
NPV and IRR
• Whether the IRR rule and the NPV rule lead to
identical decisions?
• Yes, if: 1. the cash flows of the project are
conventional, that is the first cash flow is
negative and the other following cash flows are
positive. and
• 2. the project must be independent i.e. the
project can be accepted or rejected without
reference to any other project.
01/01/2010 360
IRR
• Problems with the IRR:
• When the cash flows of the project are not
conventional (cash flows can be negative in
between) or when two or more projects are
compared to find the better one.
• It is either difficult to define or it can be
misleading.
• It cannot distinguish between short term and
long term projects and also when the interest
rates differ and so cost of capital also changes
during the project‘s life.
01/01/2010 361
IRR
• Consider a project with the following cash
flows: -160000, 1000000, and -
1000000.
• The IRR of the project is given by r in the
equation:
• -160000 + 1000000/(1+r) -1000000/(1+r)
2

= 0.
• The IRRs are 25% and 400%
01/01/2010 362
IRR
• We cannot say which of these IR is correct.
Here the IRR rule breaks down.













NPV





Discount rate (percentage)
25 400



01/01/2010 363
IRR
• There can also be cases when the NPV is
always positive and hence no IRR (See the
example in book PC 8.14)
• Mutually exclusive projects: Consider two
projects : One with small investment, smaller
absolute return and more IRR and another
with bigger investment, bigger absolute
return and smaller IRR. As per the IRR rule,
the smaller project has to be selected which
is wrong.
01/01/2010 364
IRR
• Example: Two projects A with the cash flows:
-10000 and 20000; IRR 100% and NPV at r=
12: Rs. 7,857. and B with cash flows : -50000
and 75000; IRR 50% and NPV: Rs. 16964.
• When you look at the same projects with
incremental cash flows, the IRR returns a
better figure.
• In the above case, the incremental cash
flows in the case of Project B are: -40000
and 55000., IRR = 37.50%, which is far
above the cost of capital 12 %. Hence the
project can be accepted.
01/01/2010 365
IRR
• Finally we can conclude that when we consider
two mutually exclusive projects, it is better to rely
on the NPV criterion.
• The case of different short and long term
interest rates:
• Recall that the discount rates ‗r‘ used in the
denominator for the years refer to the costs of
capital for the respective years.
• If the IRR is used as a decision criterion, then if
the IRR> the opportunity cost, then the project
can be accepted.
01/01/2010 366
IRR
• Which opportunity cost - if it changes from year
to year?
• So we have to work out a weighted average of
various rates and then compare it with the IRR.
• So in such cases, to avoid complications, the
NPV method is preferred.
• The meaning of IRR:
(1) The IRR represents the return on the
un-recovered investment balance in the project
(at the same rate for the entire project life).
01/01/2010 367
IRR
(2) the IRR is the rate of return earned on the
initial investment made in the project (at the
same rate of reinvestment of intermediate flows).
• Since the second is not always possible we may
say that the first mentioned meaning is more
realistic.
• See the example in book PC 8.16-17
01/01/2010 368
IRR
• The desirable qualities of IRR: Managers
look to the rate of return for their investments.
• Samuel Weaver says: ―The resulting IRR
can be compared to the expected inflation,
the current borrowing rates, the cost of
capital, an equity portfolio‘s return and so on‖.
• Further NPV can be calculated if you know
the exact discounting rate, but still may
vaguely, whereas the IRR arrives at it and so
can be compared with the desired (even if not
definitely known) discount rate.
01/01/2010 369
IRR
• The Modified IRR (MIRR): Whether the
shortcomings of the regular IRR can be
overcome?
• Yes by using the MIRR.
• It is that percentage at which the costs
discounted at the cost of capital are
compounded over the project life to produce the
returns.
• See the following example for clarification:
• The cash flows of a project are : -120, -80,
20,60,80,100,120 and the cost of capital = 15%
01/01/2010 370
IRR
• Step No. 1. Calculate the present value of costs
using the formula:
• PVC +  (t= 0 to n) Cash flow
t
/(1+r)
t
i.e. 120 +
80/1.15 = 189.6 assuming a cost of capital of
15%.
• Step no.2: Calculate the terminal value TV of
the cash inflows using the following equation:
• TV =  (t = 0 to n) Cash in flow
t
(1+r)
n-1
i.e.
:20*(1.15)
4
+ 60*(1.15)
3
……+ 120 = 467.
01/01/2010 371
IRR
• Step no. 3: Solve the following equation to find
MIRR:
• PVC = TV / (1+MIRR)
n
.. In this case it is:
189 = 467/(1+MIRR)
6
.
• Thus MIRR 0.162 or 16.2%. i.e. the cost of the
project is giving a return at 16.2% compounded
through the life of the project of 6 years.
01/01/2010 372
IRR
• Evaluation: The MIRR is superior since the
MIRR assumes that the project cash flows are
reinvested at the cost of capital whereas the
regular IRR assumes that the cash flows are
reinvested at the project‘s IRR. Secondly, the
problem of multiple rates does not exist.
• So, in conclusion we can say that if two mutually
exclusive projects have the same project size,
NPV and MIRR lead to the same decision
irrespective of the variations in the life of the
projects.
01/01/2010 373
Pay back period
• Pay back period: It is the length of time required
to recover the initial cash outlay on the project.
• For a project with the outflows -600000,
150000,150000,100000,1000,and 100000 the
pay back period is 5 years.
• The shorter the pay back period, the better it is
since the risk would be less.
01/01/2010 374
Pay back period
• It ignores the time value of money and also
ignores the cash flows beyond the pay back
period.
• There may be some projects with substantial
cash flows beyond the Pay back period and they
are all ignored.
• It is measure of the project‘s recovery of the
investment and about the profitability.
• It does not indicate the firm‘s overall liquidity.

01/01/2010 375
Discounted Pay back period
• Discounted Pay back period method:
• In the conventional Pay Back Period method the
cash flows are taken as they are without
recognising time value of the flows.
• This defect is removed by discounting the flows at
the appropriate cost of capital.
• See the example in book PC 8.22-24
• The pay back period method can be regarded as
the reciprocal of the IRR method when the annual
cash flows are constant and the life of the project
is fairly long.
01/01/2010 376
Discounted Pay back period
• This method is like the Breakeven point.
• The shorter the pay back period, the faster is the
uncertainty associated with the project resolved.
• Accounting Rate of return:
• The accounting rate of return is also called the
average rate of return on investment.
01/01/2010 377
Accounting Rate of return
• The common measures that are adopted are:
• Average Income after tax/Initial investment
• Average income after tax/ average investment
• Average income after tax but before
interest/initial investment
• Average income after tax but before
interest/average investment
01/01/2010 378
Accounting Rate of return
• Average income before interest and taxes/initial
investment
• Average income before interest and
taxes/average investment
• (Total income after tax but before depreciation –
initial investment)/initial investment/2) x years.
• See the example in book PC 8.24-27.
01/01/2010 379
Accounting Rate of return
• Higher the accounting rate of return, the better is
the project. Generally, those projects with
accounting rate of return greater than the
desired cut off rate of return are accepted.
• Merits of the method are:
• Accounting rate of return method is simple to
calculate;
• Based on accounting info which is readily
available;
• Considers the benefit over the entire life of the
project;
01/01/2010 380
Accounting Rate of return
• Demerits are:
• It considers accounting profit and not cash flow;
• Does not take into account the time value of
money;
• Accounting income is not defined since
depreciation method is not defined;
• The method is misleading since balance sheet
book values reflect neither the earning
capacities of the assets nor their market values.
01/01/2010 381
Assessment of various methods
• A survey by U C Rao came out with the following
finds:
• Discounted cash flow methods have gained
importance and IRR is the most popular method;
• Generally multiple evaluation models are used;
• Accounting rate of return and pay back period
method are used as supplementary methods;
01/01/2010 382
Assessment of various methods
• Weighted average cost of capital is the most
commonly used discount rate and the most often
used discount rate is 15 %in post tax terms;
• Risk assessment and adjustment techniques
have gained popularity and the most popular
technique is sensitivity analysis. The common
methods for risk adjustment are shortening the
payback period.

01/01/2010 383
Social Cost Benefit Analysis (SCBA)
• SCBA is a methodology developed for
evaluating investment projects from the point of
view of the society as a whole.
• The methodology is used generally for public
investments but it is equally important for private
investments also since they have to be approved
by various governmental and quasi-
governmental agencies which have larger
national interest in view while taking decisions.
01/01/2010 384
SCBA
• The Project Manager has to study the social
costs of the project and the social and economic
benefits the project will generate.
• The social costs are harmful to the society : like
pollution of air, noise and water, soil erosion,
deforestation, production of harmful products
etc.

01/01/2010 385
SCBA
• The social and economic benefits would be:
increase in employment opportunities-both
directly and indirectly, rise in per capita
income etc.
• The project manager has to choose the
project that is beneficial to the society.
• In SCBA, the focus is on social costs and
benefits which often tend to differ from the
monetary costs and benefits of the project.
• The sources of the discrepancies are: market
imperfections, externalities, taxes and
subsidies, concern for savings, concern for
redistribution merit wants etc.
01/01/2010 386
SCBA
• When imperfections exist, market prices do not
reflect social values.
• The common imperfections are :
• rationing (control over price and distribution – price
paid by consumer is much less than the market
price),
• prescription of minimum wage rates (wages that
have to be paid would be more than that would be
payable in a competitive labour market),
• and foreign exchange regulation (in countries where
the exchange rates are regulated, the official rate
would be less than the market rate).
01/01/2010 387
SCBA
• Examples of externalities are:
• beneficial infrastructure facilities created by the
project like roads which also benefit the
surrounding areas
• or the bad effects of environmental pollution
created by the project.
• In the first case, the project does not derive any
extra benefit but the community around the
project benefits without any payment.
01/01/2010 388
SCBA
• In the second case, the community around the
project suffers the inconvenience but the project
does not pay for it. These are relevant for SCBA.
• Taxes and subsidies: From the Project point of
view, the taxes and subsidies are monetary costs
and gains but from the social point of view they
are simply transfer payments.
• Concern for Savings: A private firm does not
have differential valuation between consumption
and savings.
In the capital-scarce developing countries, a
higher valuation is placed on savings and a lower
valuation is put on consumption.
01/01/2010 389
SCBA
• Concern for redistribution: From the social point
of view, a rupee of benefit going to an
economically poor section is considered more
valuable than a rupee of benefit going to an
affluent section.
• Merit wants –like adult education programme or
a balanced nutrition programme for school going
children - are not relevant from private point of
view but are important from social point of view.
01/01/2010 390
SCBA
• UNIDO approach:
• UNIDO approach and the Little-Mirrlees (‗LM‘)
approach emerged for SCBA in the early 1970‘s.
• The UNIDO approach has been laid out in their
publications: ‗Guidelines for Project Evaluation‘
1972 and ‗Guide to Practical Project Appraisal‘
1978.
• The method of project appraisal involves five
stages, each one measuring the desirability of
the project from a different angle:
01/01/2010 391
SCBA
• Calculation of the financial profitability of the
project measured at market prices;
• Obtaining the net benefit of the project
measured in terms of economic efficiency
prices;
• Adjustment for the impact of the project on
savings and investment;
• Adjustment for the impact of the project on
income distribution;
• Adjustment for the impact of the project on
merit goods and demerit goods whose social
values differ from their economic values.
01/01/2010 392
SCBA
• Net Benefit in terms of Economic prices:
• This is also referred to as shadow prices. When
markets are perfect, market prices will represent
economic prices.
• But in reality market has so many inefficiencies
which we have already discussed.
• Therefore there is a need to develop shadow
prices and measuring net economic benefit in
terms of these prices.
01/01/2010 393
SCBA
• Basic issues in shadow pricing:
• 1.Choice of the unit of account: UNIDO‘s
answer is : ―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 rupees‖.
• 2. Concept of tradability: For tradable goods the
international price is a measure of its opportunity
cost and hence represents the real value in
terms of economic efficiency.
01/01/2010 394
SCBA
• 3. Sources of shadow prices: UNIDO approach
suggests three sources depending on the impact
of the project on the economy::
• (i) increase or decrease in the total
consumption in the economy: shadow pricing is
the consumer‘s willingness to pay;
• (ii) decrease or increase in the production in the
economy : --shadow pricing is the cost of
production,
01/01/2010 395
SCBA
• (iii) increase or decrease in imports or exports :
shadow pricing is the foreign exchange value.
• 4. Taxes: (i) If a project results in diversion of
non traded inputs which are in fixed supply from
other producers or addition to non traded
consumer goods : taxes should be included;
• (ii) When the project augments domestic
production by other producers, taxes should be
excluded and
01/01/2010 396
SCBA
• (iii) for fully traded goods, taxes should be
ignored.
• Shadow pricing of specific resources:
• Tradable inputs and outputs: A good is fully
traded when an increase in its consumption
results in corresponding increase in import or
decrease in export or when an increase in its
production results in a corresponding
increase in export or decrease in import.
01/01/2010 397
SCBA
• For fully traded goods, the shadow price is the
‗border price‘ which is the domestic currency
equivalent converted at the market exchange
rate.
• In practice, it is reasonable to regard tradable
inputs and outputs as fully traded.
• For non traded goods, the border price does
not reflect its economic value.
• It should be measured in terms of what
domestic consumers are willing to pay if the
output of the project adds to its domestic
supplies or if the requirement of the project
causes reduction of its consumption by others.
01/01/2010 398
SCBA
• The value of a non traded good should be
measured in terms of its marginal cost of
production if the requirement of the project
induces additional production or if the output
of the project causes reduction of production
by other units.
• Non tradable inputs and outputs:
• A good is non tradable when : its CIF import
price is greater than the domestic cost of
production, and its FOB export price is less
than the domestic cost of production.
01/01/2010 399
SCBA
• Externalities: an externality is a special class of
good:
• (i) which is not deliberately created by the
project sponsor but is an incidental outcome of
legitimate economic activity, (ii) which is
beyond the control of the persons who are
affected by it, for better or for worse,
• (iii) which is not traded in the market place.
01/01/2010 400
SCBA
• Some examples already referred to earlier are:
• roads built by factory being very useful for the
people around the factory or a factory emitting
emissions causing injury to the health of the
population around the factory etc.
• The valuation of external effects is very difficult.
Because they are intangible in nature but can be
estimated by indirect means:
01/01/2010 401
SCBA
• For example, the value of better transport
provided by the approach road built by a factory
may be estimated in terms of increased
activities and benefits derived there from.
• The cost of pollution may be estimated in terms
of the loss of earnings as a result of damage to
health caused by it and the cost of time spent for
coping with the unhygienic surroundings.


01/01/2010 402
SCBA
• Labour inputs: When a project hires labour,
there can be three possible effects on the rest
of the economy:
1.It may take labour away from other
employments – shadow price would be what
other users of labour are willing to pay for this
labour,
2.It may induce the production of new workers-the
social cost would be the amount of leisure that
the labour foregoes, the additional consumption
of food that the labour would now have as a
result of increased wages and the cost of
training that the worker has to undergo to
improve his skills etc. and
01/01/2010 403
SCBA
3. and it may involve import of workers –
shadow price would be the wage they
command.
• Capital inputs: When a capital investment is
made in a project,
--financial assets are converted into physical
assets
--and financial resources are withdrawn from
pool of savings and therefore alternative
projects are foregone.
• So the questions arise as to what is the value
of the physical assets and what is the
opportunity cost of the capital ?
01/01/2010 404
SCBA
• The shadow price of the physical assets is
calculated depending on whether it is
tradable or non tradable good.
• And the opportunity cost of capital is
measured by the consumption rate of interest
which is the price the saver must be paid to
sacrifice present consumption.
• Foreign Exchange: The UNIDO method
uses the domestic currency and so the
foreign exchange inputs of the project must
be identified and adjusted by an appropriate
premium to reflect the shadow price of foreign
exchange.
01/01/2010 405
SCBA
Measurement of the impact on distribution:
• For such assessments, the income gained or
lost by individual groups within the society must
be measured first.
• The gain or loss to an individual group within
the society as a result of the project is equal to
the difference between the shadow price and
market price of each input or output in the case
of physical resources
• or the difference between the price paid and
the value received in the case of financial
transactions.
01/01/2010 406
SCBA
Savings impact and its value:
• Here two questions are raised:
• Given the income distribution impact of the
project what would be its effects on savings?
• It is equal to   Y
i
MPS
i
, where,  Y
i
= change
in income of group i as a result of the project
and MPS
i
= marginal propensity to save of
group i.
• The second question is: What is the value of
such savings to the society?
• It is the present value lf the additional
consumption stream produced when that rupee
of savings is invested at the margin.

01/01/2010 407
SCBA
Income distribution impact: Redistribution of
income in favour of economically weaker
sections or economically backward regions is a
socially desirable objective.
• This cannot happen entirely through tax, subsidy
and transfer measures.
• Therefore investment projects are also
considered as investments for income
redistribution and their contribution toward this
goal is considered in their evaluation.
01/01/2010 408
SCBA
• This calls for suitably weighing the net gain or
loss by each group measured earlier, to reflect
the relative value of income for different groups
and summing them.
• UNIDO‘s guidelines suggested that the weights,
which essentially reflect political judgements
may be determined by an iterative process
involving interaction between the analyst and the
planners.

01/01/2010 409
SCBA
Adjustment for merit and demerit goods: A merit
good is one for which the social value exceeds
the economic value. The concept of merit goods
can be extended to include a socially desirable
outcome like creation of employment rather than
dishing out unemployment dolls or create ‗food
for work‘ like jobs.
01/01/2010 410
SCBA
Little-Mirrlees (LM) approach:
• IMD Little and JA Mirrlees have developed an
approach to SCBA.
• There is considerable similarity between the
UNIDO approach and the LM approach.
• Both call for calculating the shadow prices,
consider the factor of equity and use of DCF
analysis.
01/01/2010 411
SCBA
• The differences are:
• While the UNIDO approach measures costs and
benefits in term of domestic rupees, the LM
approach measures costs and benefits in terms
of international prices (border prices).
• The UNIDO approach measures the costs and
benefits in terms of consumption whereas the
LM measures in terms of uncommitted social
income.
01/01/2010 412
SCBA
• The stage by stage analysis recommended by
the UNIDO approach focuses on efficiency,
savings and redistribution considerations in
different stages, whereas the LM tends to view
these considerations together.
• Shadow prices: The outputs and inputs of a
project are classified into the following
categories:
• 1. traded goods and services-the border price
(FOB for the exported goods and CIF for the
imported goods);
01/01/2010 413
SCBA
• 2. non traded goods and services - these are at
accounting prices defined in terms of marginal
social cost and marginal social benefit. and
• 3.labour- shadow wage rate is difficult to
determine in social cost and benefit analysis.
• It is a function of several factors: marginal
productivity of labour, cost associated with
urbanisation, cost of having an additional
amount committed to consumption due to the
higher income.
01/01/2010 414
SCBA
SCBA by Financial institutions: Financial
institutions analyse a project from the financial
profitability angle as well as from the angle of
SCBA.
• Essentially the three following aspects are
covered:
• Economic Rate of Return (ERR),
• Effective Rate of Protection (ERP)
• and Domestic Resource Cost (DRC).
01/01/2010 415
SCBA
Economic Rate of Return (ERR): This is the rate
of return the project will earn if there are no
distortions.
• The flows of costs and receipts are revalued at
their opportunity costs.
• The tradable inputs and outputs are valued at
their international prices and the non tradable
inputs and outputs are revalued at fixed
conversion factors.
• Labour is revalued at the shadow wage rate.
01/01/2010 416
SCBA
• The flow of net receipts is then discounted to
find the ERR. According the Planning
Commission, the ERR should be at least 12%
and should be more than the prevailing rate
of return.
Effective Rate of Protection (ERP): This
indicates the degree of effective protection
that a product enjoys through its production
cycle.
• The ERP measures the margin of protection
on value added in the production process
rather than on the product price.
01/01/2010 417
SCBA
• It is defined as the excess percentage of
domestic value added due to the imposition of
tariffs and other protective measures on the
product and its inputs over foreign or world
market value added.
• Tariffs and subsidies provide protection to
domestic processing activities by raising the
value added obtainable by a firm or industry.
01/01/2010 418
SCBA
• Protection permits domestic industries to
operate with a value added higher than that
under free trade, thereby providing incentives
for the movement of scarce domestic resources
into protected industries.
• The higher the ERP, the greater is this
inducement, leading to economic utilisation of
scarce resources.
01/01/2010 419
SCBA
Domestic Resource Cost: This is the most crucial
indicator of the viability of a project especially
from a macro-perspective.
• It is an indicator of the comparative advantage
in any product, as it refers to the real opportunity
cost in terms of domestic resources.
• It is useful in deciding whether a product should
be imported or domestically produced.
01/01/2010 420
SCBA
• For the purpose of calculations, the total cost of
the project is divided into two categories: rupee
and foreign exchange expenditure.
• The cost components included are: total
operating cost of the normal year, 8%
depreciation on fixed capital and a 10% return
on capital employed.
• Taxes are excluded as they are transfer
payments. Sales are revalued at world prices.
01/01/2010 421
SCBA
• The rupee expenditure and foreign exchange
saved/earned are calculated. The DRC is
compared with the exchange rate.
• A DRC lower than the exchange rate indicates
that the product could be profitably
manufactured locally.
Limitations of SCBA:
• Because of the nature of the social costs and
benefits there cannot be any standard method
or technique applicable to all types of
investments.
01/01/2010 422
SCBA
• Every project will require a different approach
while identifying and measuring its social
benefits and costs.
• Further many of the costs and benefits are
intangible and so their valuation in terms of
money is bound to be subjective due to the
biases and prejudices of the analyst.
• If all possible alternative assessments are
sought to be socially assessed, the costs would
be prohibitive.
• However the element of subjectivity can be
reduced by cross checks.
01/01/2010 423
SCBA
• In conclusion, in spite of the limitations, the
gains of the social evaluation of investments
cannot be disregarded.
• An awareness of the SCBA will enhance the
contribution of the entrepreneurs to the society
at large.
• Probably in due course of time, the social
scientists will improve the methods of
assessment used ion SCBA.
01/01/2010 424
8.Budget
• Budgetary control is a tool of management used
to plan, carryout and control the operations of
business.
• A budget is a plan of spending. It is a statement
showing how a firm would allocate its resources
during a given time period.
• In other words, it is a document that contains the
representation of the strategy of the firm in
monetary terms. It shows the resource
constraints on various activities of the firm.
01/01/2010 425
Budget
• The concepts and procedures under budget plan
and control have wide application not only in
profit oriented enterprises but in every enterprise
where the resources are limited and have to be
properly applied.
• Budget plan and control is closely related to
accounting. It also supplies info for marginal
and standard costing and flexible budgets.
• Budget plan and control gives a firm basis for
participative management.

01/01/2010 426
Budget
• It requires the involvement of all management levels
in the planning process and in the approaches for
accomplishing the goals.
• It enlightens the members of the management team
regarding the objectives of the enterprise and its
approaches. Thus it creates involvement and
commitment.
• The process of preparing the budget plan consists
of finalising the functional objectives and then
preparing the master budget.
• First step is to forecast future targets, resolve the
conflicts of sales- production-inventory problems,
determine resources and cash flows.
01/01/2010 427
Budget
• The effectiveness of budget control will be enhanced if
the organisation is divided into sub-units as decision
centres or responsibility centres.
• Total Systems Approach:
• A comprehensive budget plan and control
encompasses much more than a periodic financial
budget.
• It covers all the operations in the enterprise and
involves a total systems approach.
• A single high-ranking official or a committee of
members should be entrusted with the responsibility of
receiving and reviewing budgets from the sub-units,
and consolidating them into a master budget and its
periodical revision.
01/01/2010 428
Budget
• The budget so prepared should be in line with the
overall comprehensive objectives of the
enterprise.
• The position and forecast for the economy in
general and the industry in particular, should be
factored into the making the strategic long term
budgets and within the overall long term budgets,
short term budgets should also be prepared.
• What are the objectives of a budget?
• Entrusting the individual planner at all levels with
the budget responsibilities.
• Budgeting the performance and requirements of
each section and then using these budgets as
targets for controlling the sections and measuring
their performance.
01/01/2010 429
Budget
• Supervisors of each section should have the
responsibility for the output, quality and
cost.
• Budgetary control: Is a plan of operation
based on a forecast of sale , income and
expenditure which deals with departmental
budgets framed on the basis of policy
requirements and the responsibilities of
supervisors. This calls for a constant
comparison of the actual with the budgeted
results.
• Budgetary control , also considered as a
profit plan has become a means of effective
management control.
01/01/2010 430
Budget
• Budgets can be broadly classified as :
• Revenue and expense budgets:
• Time, space, materials, and manpower
budgets;
• Capital expenditure budgets;
• Cash budgets;
• Master operating budgets.



01/01/2010 431







































Types of Budgets
Revenue
and
Expense
Budgets
Time,
Space,
Materials
and
Manpower
Budgets
Capital
Expenditure
Budgets
Cash
Budgets
Mast
er
Oper
ating
Budg
ets
1. Sales
budget is
the
foundatio
n of
budgetar
y control.

2.Operati
ng
expense
budgets
deal item
s of
expenses
e.g. direct
labour,
materials
etc.
1. Budget
for direct
labour
hours,
machine
hours.
2.
Budgets
of units
of
materials,
units
produced
1.Financial
plan for
initial
capital
expenditur
e.
2.
Financial
plan for
growth or
expansion.
These are
tied in with
long-term
business
planning.
They give
a forecast
of cash
receipts
and
expenses.
Cash
budget is
the most
important
single
control of
a
business.
A master
operating
budget
gathers
together
data from
the several
department
s and
summarise
s them, first
in a
forecast
income
statement
and then in
a forecast
balance
sheet.
01/01/2010 432
Budget
• Advantages of Budgetary control are:
• It helps the process of panning;
• It provides an effective means by which, the
entrepreneur can delegate authority without
sacrificing his overall control;
• It keeps expenditure in check;
• It helps in coordinating the activities of an
enterprise;
• It helps in determining the policies of an
enterprise;
• It aids in measuring performance;
01/01/2010 433
Budget
• It promotes cooperation and enhances
controls on business activities.
• The steps involved in Budgetary control are:
×Preparation of the Budget, × publishing
the budget, × measuring the results, ×
comparing the performance with the
Budget, × correcting the unfavourable
variance for better growth.
• Budgeting/planning is a technique of
organizing, developing and controlling
business activity in a systematic manner.
01/01/2010 434
Budget
• Surprisingly many business do not have
planning because:
• The uncertainties in the ever changing
economic environment make the planning
(with assumptions) meaningless;
professional management talent is missing;
the tendency to follow the age-old methods
of dealing with matters; and the absence of
the reliable MIS.
• In fact these are the very reasons why a
systematic planning should be in place.


01/01/2010 435

Budgetary Control System – a diagrammatic representation.:




























Master Budget
Sales
Budget
Cash
Budget
Production
Budget
Selling and
Distribution Cost
Budgets
Capital
Expenditure
Budget
Budget for
prime costs
and overhead
costs
Stock Budget Administration
Costs Budget
Master Budget (including
Budgeted P & L A/c and
Balance Sheet)
Accounting variance
analysis reports and
statements

Action by
Management at all
levels to remove
variance noted in
performance
01/01/2010 436
Budget
• When using budget for control, comparisons
should be made between the expenditures
that should have been made and actually
made and not between what was allocated
and actually spent.
• This comparison would bring out the real
efficiency of the project.
• Budgets for the projects are prepared for one
another reason also : to arrive at the proper
pricing of the product.
01/01/2010 437
Budget
• There are different types of approaches to
make budgets or estimates of costs. The
estimating process can be classified in two
ways:
• one is based on the amount of input info
required and the accuracy:
• four types of estimates :
• Order of magnitude analysis (used when the
project is in the conceptual stage. – cost of
the project is estimated without using any
engineering data, - arrived at using the past
experience the output figure may be as low
as 35 of actual costs-)
01/01/2010 438
Budget
• approximate estimate (also without any
engineering data - made by interpolating the
expenditure on similar projects undertaken
earlier by making adjustments to price levels
– this estimate is found to vary with the
actual by about 15%) -
• Definitive estimates (are more accurate
based on detailed engineering data, well laid
out plans, clear specifications and reliable
unit prices and may vary by a small 5% from
actuals)
• and estimate using estimation manual. (in
this method, estimation manuals have to be
first prepared ………
01/01/2010 439
Budget
• ….. They contain standard costs for various
costs. And are determined taking into
account all factors such as machine down
time, lunch breaks, clean up time, set up time
etc. Thus this method can be used only for
projects which are common with other
projects based on which the manuals are
developed. Even if manuals exist, they have
to be constantly updated)
• The other process is based on whether the
estimate is made starting at the top or
bottom of the work breakdown structure.


01/01/2010 440
Budget
• In the top-down method, first the resources to be
allocated for the project as a whole is estimated.
• Such estimate is broken down into various
individual tasks for all the levels upto the lowest.
• In this method, the assumption is that the people
at the lower level tend to overstate the resources
as well as the time required to complete the
project.
• Here there is no atmosphere of trust. The process
may develop strains in the relationships with the
staff at lower levels.
• Moreover the senior level staff do not want to
share the power of decision making with the
juniors.
01/01/2010 441
Budget
• The advantage in this method is that since
the total budget is fixed by the top
management, only the essential activities will
be funded
• The other method, the bottom-up budgeting
is the reverse in the approach to the top-
down approach.
• The estimation starts at the smallest work
element at the lowest level.
• Estimates of machine hours and man hours
are then converted into rupees.
• All such estimates at all levels are
aggregated to arrive at the total direct cost of
the project.
01/01/2010 442
Budget
• Then the general and administrative
overheads are added , some margin for
contingencies and profit.
• The advantage of this method is the high
level of accuracy that can be achieved.
• Since the estimates are made by all level of
employees they would be fully committed to
the success of the project.
• The disadvantage is the fact that on the
expectation of pruning down by the seniors
before finalisation, the juniors are most likely
to inflate the estimates.
01/01/2010 443
Budget
• The Budgeting Process:
• 1.Ideally the estimates are based on similar
tasks done earlier.
• But the tasks in different projects may not be
the same and moreover it will be difficult to
predict the level of prices after the lapse of
a few months or years.
• 2.after aggregating all the costs and other
resources needed for the whole project, and
a total cost analysis is made, the task of
allocation of the resources – money,
equipment and people- have to be made.
01/01/2010 444
Budget
• 3.The Kick-off meeting: A meeting of all the
people who are involved in the process of
budget making from all the departments is
called.
• In the meeting, the WBS is discussed so that
every body understands the roles and
responsibilities assigned – which is
essential for achieving consistent and
reliable estimates.
• 4. Subsequent meetings may be required for
further deliberations or clarifications but only
the departmental managers are called and
they would be expected to coordinate the
project activities of their departments with
the project office.
01/01/2010 445
Budget
• 5.Underestimates in the case of an in-house
project may be managed by increasing the
price of the end product, but underestimates
while submitting tender documents will
result in loss to the firm.
• 6. Estimation of labour requirements: All the
line departments estimate the labour
requirements for each task assigned to them
in man hours.
• The project office consolidates all the
requirements to arrive at the total figure. And
then converts into rupees by applying the
appropriate wage rates.
01/01/2010 446
Budget
• It is a difficult exercise to predict the wage
levels for the future and therefore suitable
escalations have to be in built.
• 7. Estimation of overheads: Control of both
the direct costs as well as the indirect costs
viz. overheads is important.
• Normally overheads of a project are more
than the direct costs . It would be unwise to
allocate resources to the R & D dept. from
the revenue that would be generated by the
user department as there may be lean
periods of revenue generation some time.
01/01/2010 447
Budget
• 8. Estimation of materials and support
services: The quantities are estimated as per
the engineering standards.
• The description of the materials required,
name of the supplier, expected cost, duration
of shelf life and the estimated scrap value are
all the details that are passed on to the
project office by all the departments.
• Estimates of expenses for support activities
like expenses to be incurred on travelling,
transportation of materials etc. are estimated
to be 3 to 5 % of the total direct cost.
01/01/2010 448
Budget
9. Pricing the project: From the estimates of the
different types of costs mentioned earlier, the cost of
the total project is arrived at.
If the project is internal to the firm, then the total cost
of the project arrived at will be the project budget.
But if the project is to be executed for an outside client,
then the margin of profit has to be added to the total
cost and quoted to the client as the price.
The margin of profit depends on whether the firm is
interested in getting the contract for strategic
reasons or for profit.
Price from the strategic angle will be low. Further it
also depends on the stance of the competitors –
whether they are also interested in the project for
strategic reasons or for profit?
01/01/2010 449
Budget
• Some firms quote prices even at a loss in
order to capture the contract viewing them
as investments to capture more and more
future contracts, income from servicing or
getting into a new line etc.
• If the project is for commercial
considerations, then adequate profit margin
has to be added.
• If there is going to be a long time gap
between quoting and executing the project
appropriate cost escalation clauses have to
be incorporated.
01/01/2010 450
Budget
• A very low quotation also has its disadvantages :
• the client may suspect the ability of the firm or the
output quality or the time required;
• the funding agencies may also think on similar
lines and reject the funding proposals.
• The usual pitfalls in pricing are :
• Not defining the scope of the project properly;
• Over optimistic project schedules resulting in
spending more on manpower than required;
• Inaccuracies in the WBS;
• Statement of work lacking clarity resulting in
misinterpretations;
01/01/2010 451
Budget
• Mismatch in the skills required and actually
assigned;
• Inadequate provisions for contingencies and cost
escalations; and
• Use of inappropriate techniques for estimates. .
• 10. Budgeting techniques: Two techniques which
were used earlier and not so popular are :
• Zero Based Budgeting (ZBB) (Every time funds are
to be released, the projects are reviewed
sometimes resulting in scrapping of the project
altogether – this demoralises the people working
on the project)
• and Planning, Programming, Budgeting system
01/01/2010 452
Budget
• Life Cycle Costing: Earlier, the approach of the
project sponsors or entrepreneurs was to take into
account all the expenditures needed to implement
the project and start commercial production and
look no further beyond that point.
• This is a grave mistake as can be explained with
the example of a cement plant.
• A sponsor may choose to put up a plant based on
the wet process since it is cheaper for
commissioning but the further maintenance costs
would be high.
• Whereas a plant based on the dry process would
cost high initially for commissioning but further
maintenance costs would be much lower.
01/01/2010 453
Budget
• Considering the life time of the project, it
would be sensible to opt for a plant with the
dry process.
• This is what Life cycle costing system about.
In this system, choices made are evaluated
against the total life cycle costs of the
system.
• This system takes into account the cost of R
& D, production costs, operating and
maintenance costs, construction costs and
phase out costs.
• Costs under these heads are calculated for
each of the short listed projects and then
decision is taken based on the aggregates.
01/01/2010 454
Budget
• This system has got its defects too:
• Life cycle costing system is expensive and
so suitable only for large projects;
• The entire exercise has to be repeated
whenever the requirements undergo a
change;
• and it assumes that the life of the products is
finite and is known.


01/01/2010 455
Project Cash Flows
• Estimates of cash flows are a key element in
any investment and is one of the most
difficult steps in budget making.
• The example of the Alaska Oil pipeline
would do to show how crucial is it in the
process –the pipeline which was estimated
to cost $700 mn finally ended up in $7 bn.
(i.e. ten times the original estimate).
• This exercise involves many variables and
different people participate in it:
• Capital outlays by the Engg. and product
development depts.,
01/01/2010 456
Project Cash Flows
• revenue projections by the marketing dept.,
• the operating costs by the production dept.,
• cost of raw materials and stores by the
purchase dept.,
• and then there are cost accountants,
personnel executives, and others.
• The role of the finance manager is very
crucial in the process since he has to
coordinate all the depts., and ensure that the
forecasts are based on a set of consistent
economic assumptions, with the focus on
the relevant variables and as far as possible
eliminate biases inherent in the process.
01/01/2010 457
Project Cash Flows
• 1.Elements of the Cash flow stream:
• For a project, the relevant cash flows are the
incremental post-tax cash flows.
• For a conventional project they are :
• the initial outlay( after tax cash outlay on
capital expenditure and the networking
capital when the project is set up)
• then the operating cash flows (the after tax
cash inflows resulting from the operations
of the project during the economic life of the
project)
• and the terminal cash flow (the after tax
cash inflow due to the liquidation of the
project at the end of its economic life)
01/01/2010 458
Project Cash Flows
• Time Horizon for analysis: This is the
minimum of the following :
• physical life of the plant ( period during
which the project is physically usable
condition)
• technological life of the plant (the period of
time during which the technology would not
become obsolete)
• product market life of the plant: (the period
during which the product has a reasonably
satisfactory market. The earlier two criteria
may still be valid but the market for the
product may diminish or even disappear.)
01/01/2010 459
Project Cash Flows
• Investment planning horizon of the firm: (for
infrastructure projects, the life may extend
even upto 30 years)
• 2. Basic principles of cash flow estimation:
• Separation principle: the cash flows out of
the investment and financing should be
separated.
• Take the example of a firm investing an
amount of Rs. 1000 and generates cash flow
of 1200 at the end of one year i.e. the rate of
return is 20%.(cash flows are -1000 and
+1200).
• Suppose the entire amount of Rs. 1000 will
be financed by debt at the rate of 15% pa.
01/01/2010 460
Project Cash Flows
• Then the cash flows associated with the
financing are +1000 and -1150. implying the
cost of capital of 15%.
• The return from the project should alone be
taken into account while calculating the
cash flows from the project. The interest
outgo of 150 is taken as the cost of capital.
• Incremental principle: The cash flow of the
project must be measured in terms of
incremental terms.
• This is in the case of a running firm which
starts a project.
01/01/2010 461
Project Cash Flows
• Project cash flow = (For an existing firm): cash
flow for the year with the project – cash flow
for the year without the project.
• While calculating the incremental cash flows,
one should consider all incidental effects – i.e.
the project may have been incidental to add
more profit for the other activities of the firm or
might have taken away the incomes of the
project from the other activities.
• If the project results in product
cannibalisation, then if the market has no
barriers and is full of competition, the
cannibalisation effect has to be ignored (if
considered, it may lead to wrong decisions to
drop the project resulting in losing the market
altogether).
01/01/2010 462
Project Cash Flows
• On the other hand if there are entry barriers
and not much of competition, then the
cannibalisation effect has to be considered.
• Ignore sunk costs: Supposing that a firm
spends a sum of Rs.20 lakhs for conducting
preliminary studies for generating
information about the project, the cost is
already incurred and lost anyway
irrespective of whether the project is
accepted or not. Such sunk costs should be
ignored.
• Include Opportunity costs: When a project
uses the resources already available with the
firm, the opportunity costs should be taken
into account.
01/01/2010 463
Project Cash Flows
• Question the allocation of overhead costs:
What matters is the incremental overhead
costs attributable to the project . Some other
overheads of the firm allocated to the project
for the purpose of sharing may be ignored.
• Estimate working capital properly: The
outlays have to be considered properly . The
working capital at the end of the project is
assumed to have a salvage value equal to its
book value
01/01/2010 464
Project Cash Flows
• Post tax principle:
• Cash flows should be measured in post-tax
terms. Since the income from the project is
marginal i.e. additional, the marginal tax rate
should be considered for estimating the tax
liability of the project.
• Treatment of losses:
• The general principle is:
• If the firm incurs losses (whether the project
alone makes profit or loss) : defer the tax
savings till the firm makes profits.
• If the project loses but the firm makes
profits: take tax savings in the year of loss;
01/01/2010 465
Project Cash Flows
• If both the firm and the project make profits:
consider taxes in the year of profit
and
• In the case of a standalone project: defer tax
saving until the project makes profits.
• Effect of non-cash charges: In India as per
the IT act, the admissible method of
depreciation for corporate taxation purposes
is the written down method. (Buildings5%,
Plant and machinery15%, Computers60%,
Vehicles on hire 40% Pollution control
equipment 100%)


01/01/2010 466
Project Cash Flows
• Consistency principle:
• Cash flows and the discount rates applied to
these cash flows should be consistent with
respect to the investor group and inflation.
• Cash flows to all the investors : (equity holders
+ lenders)
• = PBIT(1-tax rate) + non cash charges –Capital
expenditure –change in the working capital
• If you consider the cash flows from the point
of view of the equity investors alone then it
changes to :
• The figure in the previous step – preference
dividend-repayment of debt +proceeds from
debt issues-redemption of preference capital
+proceeds from preference issues.
01/01/2010 467
Project Cash Flows
• The discount rate applied for cash flow to all
investors is the weighted average cost of
capital and for cash flow to equity is the cost
of equity.
• Generally, the cash flow to all investors is
considered and hence the weighted average
cost of capital is applied.
• Inflation: When the cash flows are in nominal
terms, the discount rate is also nominal and
if it is real cash flow then real discount rate.
• However, generally nominal cash flows are
used and hence nominal discount rates
should be used.
01/01/2010 468
Project Cash Flows
• Cash Flow Illustrations: See PC Pages 9.10
onwards.
• Viewing a project from different perspectives:
• A project can be viewed from four distinct
points of view and they are:
• Equity point of view;
• Long term funds point of view; (Long term
funds = equity + Long term debt)
• Explicit cost funds point of view: (Explicit cost
funds = Long term funds + short term debt)
and
• Total funds point of view. (Total funds = Long
term funds + current Liabilities)
• The cash flow components slightly differ from
one another.
01/01/2010 469
In capital budgeting, the most common view is that of explicit cost
funds.
Examples involving this view: see exhibits 9.2 and 9.3 in PC.
Net cash flows relating to explicit cost funds:

Year 0 Year1…
1.Fixed Assets
2.Net working Capital
3.Revenues
4.Costs (other than dep. and interest)
5.Depreciation
6.Profit before tax:
7.Tax
8.Profit after Tax
9.Net salvage value of fixed assets
10.Recovery of nwc.
11.Initial outlay (1 + 2)
12.Operating cash inflow ( 8 + 5)
13.Terminal cash inflow (9 + 10)
14. Net cash flow (11+12+ 13)


15. Book value of investment

01/01/2010 470
Project Cash Flows
• = {- equity funds committed to project +
(Profit after tax – Preference dividend +
depreciation +other non cash charges) + Net
salvage value of fixed assets + Net salvage
value of current assets – repayment of term
loans –redemption of preference capital –
repayment of working capital advances –
retirement of trade credit and other dues. }
01/01/2010 471
Cash flows relating to equity:-Contributions made and benefits
receivable by equity holders.: (See example in exhibit 9.6 in PC)

Year 0 Year1…
1.Equity funds
2.Revenues
3.Operating Costs (other than dep. and
interest)

4.Depreciation
5. Interest on WC advance
6.Interest on term loan
7..Profit before tax:
8.Tax
9.Profit after Tax
10.Preference dividend
11Net salvage value of fixed assets
12Net salvage value of current assets
13Repayment of term loans
14Redemption of preference capital
15Repayment of short term bank borrowings


16. Retirement of trade creditors
17.Initial investment (1)
18.Operating cash flows (9 -10 +4)
19.Liquidation and retirement cash flows (11 +
12 -13-14-15-16)

20.Net cash flow (17 + 18+19)

01/01/2010 472
Project Cash Flows
• Cash flows relating to Long term funds: (see
example in exhibit 9.7 in PC):
• = - (Fixed Assets + Working Capital Margin)
• + {PAT + Dep. + Other non cash charges +
Int. on LT borrowings(1-t)
• + Net salvage value of fixed assets + Net
recovery of working capital margin.

01/01/2010 473
Year 0 Year1…
1.Fixed assets
2.Working capital margin
3.Revenues
4. Operating costs
5.Depreciation
6. Interest on WC advance
7.Interest on term loan
8.Profit before tax:
9.Tax
10.Profit after Tax
11Net salvage value of fixed assets
12Net recovery of WC margin
13Initial investment (=1+2)
14Operating cash inflow = (10+5) +7(1-t)
15Terminal cash flow =11 + 12


16.Net cash flow (13 + 14+15)

01/01/2010 474
Project Cash Flows
• Cash flows relating to total funds: (See
example in exhibit 9.8 in PC)
• - Initial investment (i.e. fixed assets + current
assets)
• + PAT + dep.+ other non cash charges + Int.
on LT borrowings (1-tax rate) + int. on ST
borrowings (1-tax rate)
• + Net salvage value of fixed assets + net
salvage value of current assets.
01/01/2010 475
Yea
r 0
Year1

1.Total funds
2.Revenues
3. Operating costs
4.Depreciation
5. Interest on WC advance
6.Interest on term loan
7.Profit before tax:
8.Tax
9.Profit after Tax
10.Net salvage value of fixed assets
11.Net salvage value of current assets
12.Initial investment (=1)
13. Operating cash inflow = (9+4) +6(1-t) + 5 (1-t)
14.Terminal cash flow =10 + 11


15.Net cash flow (12 + 13 + 14)

01/01/2010 476
Project Cash Flows
• Cash flows for a replacement project: (See
example in 9.4 in PC)
• Unlike the case of new or expansion
projects, estimating the relevant cash flows
for a replacement project is somewhat
complicated because the incremental cash
outflows and inflows in relation to the
existing project have to be determined. The
three components of the cash flow stream
for a replacement project are defined as
follows:
01/01/2010 477
Net Cash Flow = (1) + (2) +
(3)
(1) : - Initial Investment :
- (Cost of the
new assets +
Net working
capital required
for the new
asset) -
(After tax
salvage value
realised from
the old asset +
Net working
capital required
for the old
asset)
(2): + Operating cash
inflows:
+ Operating
cash inflows
from the new
asset -
Operating cash
inflows from
the old asset
had it not been
replaced
(3): + Terminal cash flow : + After tax
salvage value
of the new
asset +
Recovery of net
working capital
associated with
the new asset -
(After tax
salvage value
of the old
asset, had it
not been
replaced +
Recovery of net
working capital
associated with
the old asset )
01/01/2010 478
Year 0 Year1…
I: Investment outlay:
1. Cost of new asset

2.Salvage value of old asset
3.increase in nwc
4.Total net investment = -(1-2 +3)
II: Operating inflows over the life of the project:
5. After tax savings in manufacturing cost

6.Dep. on new machine
7.Dep. on old machine
8.Incremental dep. = 6-7
9.Tax savings on incremental dep.= 8 x 0.4
10.Net operating cash inflow= 5 + 9
III: Terminal cash inflow:
11.Net terminal value of new machine

12.Net terminal value of old machine
13. Recovery of incremental nwc.
14.Total Terminal cash inflow =11-12 + 13


IV: Net cash flow (4 + 10 + 14)

01/01/2010 479
Project Cash Flows
• How Financial institutions and Planning
Commission define cash flows:
• Financial institutions:
• Cash outflow: = Capital expenditure on the
project (net of interest during
construction) +
Outlays on working capital
01/01/2010 480
Project Cash Flows
• Cash inflow: = Operating Inflow (i.e. PAT +
Dep.
+ int. on lease rental )
+ Terminal Inflow ( i.e.
Recovery of
wc at book value + residual
value
of capital assets
i.e. land at 100% and
other capital assets at 5% on
initial cost).
01/01/2010 481
Project Cash Flows
• For IRR purposes, the max. life of the project
would be 12 years in general and may be
shorter depending upon the rate of
technological obsolescence.
• There are some minor differences between
the way the financial institutions define and
we have defined the cash flows from the total
funds point of view.


01/01/2010 482
Cash flow stream
defined by the financial
institutions
Cash flow defined from
the total funds point of
view
Initial investment Capital expenditure on
the project (net of
interest during
construction period) +
outlay on working
capital
Same as in Financial
institutions
Operating cash flow PAT + Dep.
+ INTEREST..
PAT + Dep.
+ INTEREST (1-T)
Terminal Cash Inflow Recovery of WC at book
value +Residual value of
capital assets (LAND AT
100% AND CAPITAL
ASSETS AT 5% OF
INITIAL COST)
Recovery of WC at book
value +EXPECTED NET
SALVAGE VALUE OF
OTHER ASSETS

01/01/2010 483
Project Cash Flows
• Planning Commission:
• The “Manual for preparation of feasibility
reports” developed by the Planning
Commission has prescribed certain rules in
this regard.
• Interest during construction period should
not be allowed for in the year wise capital
expenditure figures since it is implicitly taken
into account by the discounting procedure.
(Any replacement expenditure incurred
during the life of the project should be
allowed in the year of occurrence)
01/01/2010 484
Project Cash Flows
• Returns should be defined on a gross basis
as operating revenues minus operating
costs.
• Depreciation and financial charges on capital
expenditures covered by the capital cost
figures should not be deducted in defining
returns.
• They are allowed for implicitly in the
discounting procedure.

01/01/2010 485
Project Cash Flows
• Capital cost estimates generally do not allow
for funds required for wc purposes, which
are assumed to be borrowed, but only for the
margin on wc.
• In this case, the operating cost estimates
must include interest payments on funds
borrowed for working capital.
• In some cases involving the use of fixed
interest term loans for capital expenditure,
an IRR on own funds may need to be
presented.
01/01/2010 486
Project Cash Flows
• In such cases, the initial capital cost figures
should cover only the expenditures out of
equity capital.
• Repayment of term loans and interest due
on them should be allowed for in the
subsequent years as and when they are
expected to arise.
• Costs and returns should be calculated over
the entire life of the project or over 25 years
whichever is less.
• The returns should allow for a salvage value
of assets at the end of the period.

01/01/2010 487
Project Cash Flows
• So the following observations are in order:
• A project may be viewed from the point of
view of equity capital or long term funds.
• Cost and return streams have been defined
consistently with the point of view adopted.
Further they are defined in pre-tax terms.
• A fairly long planning horizon is envisaged.
This perhaps reflects the fact that the
projects considered by the Planning
Commission, in general , have a long
economic life.
01/01/2010 488
Project Cash Flows
• Biases in Cash Flow estimation:
• Overstatement of profitability:
• Native optimism (overestimates of
themselves); Attribution error (wrong
perceiving of the causes of events, taking
credit for positive results and attributing
failures to other causes);
• anchoring (holding on to their beliefs even if
contrary evidences are available)
• Myopic euphoria ( Each person‟s favourable
opinion is reinforced by the opinions of
others in the group);
01/01/2010 489
Project Cash Flows
• Competitor neglect (neglecting the
capabilities of the competitors in similar
lines of business);
• Organisational pressure (every sponsor
exaggerating the benefits of his project to
get accommodation within the budget of the
organisation);
• Stretch targets ( Managements set stretch
targets for motivating their employees.
Nobody likes to listen to pessimistic news
even if true)

01/01/2010 490
Project Cash Flows
• Tempering the optimism:
• Too much of optimism is bad. Management
should look at the results of similar outside
projects to arrive at reasonably optimistic
targets.
• For taking an „outside view‟ Daniel Kaheman
and Amos Tversky suggest the five step
procedure: Select a reference class, Assess
the distribution of outcomes, Intuitively
predict your project‟s position in the
distribution, Assess the reliability of your
prediction and Correct the intuitive estimate.
01/01/2010 491
Project Cash Flows
• Putting optimism in place: Daniel…. says
that there needs to be a balance between
optimism and realism – between goals and
forecasts. Aggressive goals may motivate
the people but outside view forecasts should
be used to decide whether or not to make a
commitment in the first place.
• Understatement of profitability:
• The opposite kind of bias can occur while
forecasting the terminal cash flows and may
understate the profitability and due to this
some of the projects which can otherwise be
accepted may be rejected.
01/01/2010 492
Project Cash Flows
• For example, defining the salvage value of
the assets at 5% of the initial cost: This may
happen due to :
• underestimating the salvage value (actual
wear and tear is much less than the
depreciation provided) ;
• ignoring intangible benefits; (the project may
establish a market position, create an R & D
capability , enhance distribution network,
and build brand loyalty);
• and Value of future options is overlooked
(new investment opportunities are opened
up through this project).
01/01/2010 493
9.Materials Management in Project
Planning-Procurement, storage and
disposal
• Different varieties of quality materials have to
be procured in adequate quantities at the
right price, stored safely in a proper place ,
used judiciously during the execution of the
project and the waste if any have to be
disposed efficiently.
• Here are some „right‟ parameters about the
material required for the project:
-right price; -right quality and right
technology;………
01/01/2010 494
Procurement Planning
• ……..-right engineering parameters; -right
lead time; -right quantity; -right source;
-right packaging; -right transportation;
-right handling methods; -right insurance;
-right legal contracts; -right place of
delivery; -right ethical standards;
• According the PMBOK: “Project procurement
Management is a process of acquiring
goods and services from a firm external to
the performing organisation.”
01/01/2010 495
Procurement Planning
• There are seven key components in a project
procurement management system :1.project
procurement planning, 2.solicitation
planning, 3.solicitation, 4.source selection,
5.contracting, 6.contract administration and
7.contract closing.
• 1. Project procurement planning: It is the
process of discovering the needs of the
project that can be satisfied by acquiring
products and services from firms external to
the project organisation.
01/01/2010 496
Procurement Planning
• It involves the questions: What to procure
and then how and when?
• Centralised procurement process has its
advantages of cost savings.
• The organisation may have policies to
procure all materials from a single or
multiple suppliers.
• Before this process begins, some
documents relating to the project would
exist and they can be taken as guide:
• They are Scope statement,. Product or
service description/ PBS, procurement
sources, market conditions, make or buy
analysis.
01/01/2010 497
Procurement Planning
• The project manager usually resorts to the
CPM and PERT techniques to estimate the
timings of the products or services to be
procured.
• So defining the needs of the project is the
most crucial task of the Project manager.
• The product or service description provides
information pertaining to the technical
specifications of the products which are to
be kept in mind while procuring.
01/01/2010 498
Procurement Planning
• Though the content and format of a product
or service description statement vary from
product to product and from project to
project, it must be elaborate enough to
support the latter stages of project planning.
^Usually product or service specifications are
written or graphical representations
consisting of:
+ Design specifications (the physical
characteristics of the product),
01/01/2010 499
Procurement Planning
+performance specifications ( the required
operational capabilities of the end product)
+and functional specifications (part of the
performance specifications and identified
only when the vendor mentions the utility of
the product or service).
^Procurement resources: Description of the
resources –systems and personnel- needed
to procure the products and services from
the market as per the specifications given in
the product.
01/01/2010 500
Procurement Planning
• If the project is complex, then the presence
of a specialised procurement team is
necessary so as to properly communicate to
the suppliers of the critical supplies and
procure them at the right time.
^Market conditions: The purchase manager
should be well conversant with the market –
products available in the market, terms of the
vendors, inflation rates, interest rates ,
ordering costs and the WBS etc.
01/01/2010 501
Procurement Planning
^Make or buy analysis: When the Project
Manager is armed with the required info
on the required product and the market
conditions, he has to decide whether to
procure them from within the organisation
or from outside.
+Making the product/s within the
organisation has its advantages of control
on quality, delivery schedule, and savings
on costs.
+But if that is not possible, it is better to
procure the material from the appropriate
vendors.
01/01/2010 502
Procurement Planning
+Such „Make or Buy‟ decisions should
be taken after considering the direct as
well as indirect costs (ordering cost,
transportation cost etc.), the
organisation‟s point of view and also
the timeliness of the needs of the
project.
Reasons for Making:
1. Lower Production Costs;
2. Unreliable suppliers;
3. Assurance of supply of
adequate quantity;
4. Utilisation of surplus
labour capacity;
5. Quality Control
and
1. Protection of special
design or quality
(Copyrights/Patents)

Reasons for buying:
1. Inadequate capacity in own
manufacturing;
2. Reduction of inventory
costs (JIT);
3. Ensuring alternate sources
of supply;
and
4. Easy availability of
standardised materials
Procurement….
^Expert judgement: Analysis of the
procurement process can be done by the
specialists if available in the firm, or by the
consulting firms or by the professional,
technical associations conversant with the
products.

01/01/2010 505
Selection of vendors
• In the process of selection of the vendor, the
vendor and the project manager try to pass on
the risks to the other, at he same time
expecting good performance.
• The contracts that the project manager would
enter with the vendor may be of different types
such as :
• Fixed Price (FP) contracts: - the price is
negotiated by the vendor and the project
manager and agreed upon a fixed price;
- the vendor has to absorb any losses or profits
due to subsequent increase or decrease in
prices;
01/01/2010 506
Selection of vendors
- --the process may be time consuming since
the vendor may take more time to assess the
risks over the contract period to arrive at the
price profitable to him;
- the vendor may even inflate the price in
anticipation of future increase in costs;
• Cost plus Fixed Fee (CPFF) or cost plus
percentage fee: In this type of contract, the
project bears all the costs of the product or
service and the vendor is paid a fixed fee for
supplying the goods.
01/01/2010 507
Selection of vendors
• --In this type of contract, the risk is with the
project manager and not the vendor.
(example is a building contract, where the
owner of the plot bears the costs of all
materials and the labour and the vendor is
paid a percentage of commission);
--the project manager is not assured of the
final cost; there is no reward for the vendor if
time and cost are saved..
• Guaranteed maximum and shared savings
(GMSS) contracts:
01/01/2010 508
Selection of vendors
--The vendor is not selected by tender and has
to complete the contract within the
„guaranteed maximum‟ amount.
--If the cost exceeds this „guaranteed
maximum‟, it is for the vendor to make up
and the savings if any, (i.e. „maximum‟ minus
the actual cost) is shared by the vendor and
the project.
01/01/2010 509
Selection of vendors
--In this type, the cost to the project is limited
by a definite amount.
--Price negotiation has to be done carefully in
order to avoid the inflation of the „guaranteed
maximum‟ amount.
• Fixed price incentive fee (FPIF) contracts”:
--This is similar to the FP with the difference
that if the vendor is able to minimise the
costs, then the saving is shared by the
project and the vendor.
01/01/2010 510
Selection of vendors
• Cost plus incentive fee (CPIF) :
--This is similar to the CPFF except for the
flexibility of altering the fee based on a
formula which compares the total project
costs with target costs.
--Usually organisations handling R & D type of
projects enter into these types of contracts
and the vendors are the maximum risk
takers.
01/01/2010 511
Selection of vendors
• It is necessary for the top management and
the project manager to plan procurement
management very carefully and prepare the
procurement management plan and
statement of the work.
• The factors influencing the selection of the
contract method are : Degree of risk
involved in terms of cost and time;  nature
and technical risk involved;  degree of
competitive dynamics in pricing; 
evaluating the price of the product or
service;……
01/01/2010 512
Selection of vendors
…… level of exigency of the requirement; 
the vendor‟s risk absorption capacity; and
his financial management system 
consistency of the vendor‟s commitment to
the project.
• The Procurement Management Plan: Is the
document detailing how the processes would
be managed from solicitation planning till
closing the contracts:
01/01/2010 513
Selection of vendors
• the type of contracts, the persons in charge
for developing the estimates for evaluation
purposes, managing multiple vendors,
combining the procurement activities with
scheduling etc.
• Statement of work: A detailed, precise and
transparent description of the product or
service to be procured for the vendor to
decide on his capabilities to take up the
assignment.
01/01/2010 514
Selection of vendors
• The details will vary depending upon the
nature of the product or service of type of
contract.
• The statement may be periodically revised by
rephrased depending on the ongoing
interactions with the vendor.
• Procurement Document: This is a document
that is used to invite proposals from the
eligible vendors.
01/01/2010 515
Selection of vendors
• Generally the words bid and quotation are
used when the product or service to be
procured is price sensitive and much
sophisticated.
• The word proposal is used when non
financial aspects like technical skills is in
focus and is used while inviting architects
and consultants.
01/01/2010 516
Selection of vendors
• A typical RFP cover many topics such as: A
brief overview of the project, product
specifications, mode of supply of
products/services, mode and time of
payment, insurance of the product/services,
names of the key people with authority and
responsibility to take decisions etc.
• The format should be designed in such a way
that it elicits in-depth, accurate and complete
information from the vendor.
01/01/2010 517
Selection of vendors
• Criteria for judging the vendor: Some of the
factors are:
Total cost of procurement;  vendor‟s
capacity to deliver at lowest cost; 
technical expertise,  management style,
and  financial position.
• Solicitation: The next stage is solicitation.
It is the process of obtaining quotations,
bids, offers or proposals from all the
prospective vendors. This involves:
01/01/2010 518
Selection of vendors
×short-listing the vendors : The list should
contain all the info about their expertise in
different functional areas.
If not readily available from sources like
associations, then meeting with customers
of the vendors, visiting their sites, enquiring
from their bankers etc.
×meetings with the vendors: These meeting
precede the proposals from the vendors and
are used to eliminate all the communication
gaps regarding the needs of the project and
prepare the ground for further negotiations.
01/01/2010 519
Selection of vendors
The negotiating team may comprise of
experts from all the relevant functional
departments.
When consensus is arrived at on all the
relevant issues, both the sides sign the
written contract incorporating the terms
and conditions.
01/01/2010 520
Selection of vendors
Advertising: This is a tool used by the project
organisation to invite proposals from
vendors through sealed bids.
There is no negotiation of price and the lowest
bid is usually accepted.
Advantage of advertising is that a data base of
potential vendors can be created from the
responses received for the advertisement.
For the projects involving the government,
advertising in mass media is mandatory.
01/01/2010 521
Selection of vendors
• Vendor Selection: This is the process
of receiving proposals from
prospective vendors and evaluating
these proposals to choose the right
vendor. The proposals are classified
into technical and commercial and
both are evaluated separately in each
and every proposal. The tools used for
selecting a vendor are:
01/01/2010 522
Selection of vendors
• Contract negotiation:
• Is a process aimed at enhancing the
clarity and ensuring mutual consensus on
the structural and procurement aspects
mentioned in the contract, before signing
it.
• The topics to be covered in the contract
are: price of procurement, technical
approach, management style, terms and
conditions, legal bindings etc.
• The contract may be in the form of a MOU
in the case of highly complex and
technical products.
01/01/2010 523
Selection of vendors
• Weighing system: Is a process in which all
the info pertaining to the qualitative
aspects of the vendor is quantified.
• It involves identifying and scoring all the
significant activities from the proposal,
setting up a range for qualifying them
based on the significance level and
weighing them against the total scores.
• Screening system: Is a process of
establishing basic performance standards
for qualifying the proposals and the
vendors have to qualify in the
performance specification test developed
by the screening system.
01/01/2010 524
Selection of vendors
• Developing independent estimates: This
process is aimed at checking the authenticity
of the price quoted by the vendor.
• The project organisation develops its own
estimations of product pricing.
• Any gap between the vendor‟s and vendee‟s
price estimates indicates that the data in the
statement of work is insufficient or the
vendor failed to correctly interpret the
statement of work.
01/01/2010 525
Contracting….
• Contracting: After selecting the vendors and
evaluating their quality thoroughly, the
project organisation has to sign contracts
with the vendors to bind them legally to
deliver the specified product.
The project organisation is also responsible
for paying the vendor the agreed price on
the successful completion of delivery.
01/01/2010 526
Contracting….
• In general, the contract should contain: the
definitions of
• vendor, vendee;
• responsibilities of the vendor and vendee;
• the type of contract being administered and
the mode of payment;
• the process of change requisition and its
approval;
• vendor‟s warranty/guarantee for the
product;
• terms and conditions of closing the
contract and consequences for deviating
from the agreement like late delivery etc.

How to order materials?
• 1) Electronic Ordering (Transactions Between Firms
via Electronic Data Interchange –EDI; Involves
standardized Data Transmittal Format through
Computers; Reduces Paper Transactions; Speeds
Up The Procurement Time.)
• 2) Stockless Purchasing (Arrangement in which a
supplier holds the items ordered by the customer in
its own warehouse, and releases them as and when
required by the customer)
• 3) Just in Time Purchasing (JIT originated in Japan
& is generally associated with the Toyota motor
company - JIT purchasing is directed towards the
reduction of waste i.e. excess inventory and delay
such that items only move through the production
system as and when they are needed)
Points to be kept in mind..
By the Project Manager while procuring materials:
• Price Volatility
• Timely Availability
• Limited Storage Space



01/01/2010 529
Contract administration
• Contract Administration: according to
PMBOK, Contract Administration is the
process of making sure that the vendor‟s
performance satisfies the project needs
mentioned in the contract.
• If there are many vendors, then they
should all be handled.
• In short, contract administration is about
applying the project management
practices to the vendor-vendee
relationship integrating the results of
these practices back into the project.
01/01/2010 530
Contract administration
• The project management practices that are
built into the contract are :
×Project planning and implementation – to
check whether the vendor is progressing as
per the schedule;
×Progress reporting : to check the vendor‟s
performance in terms of cost, time and
technical aspects;
×Quality management : to check and
constantly monitor the quality of the product
being produced;
01/01/2010 531
Contract administration
×Change management : to check the approval
and implementation of potential changes and
communicating the incorporated changes to
the people requiring it;
×Financial management : to ensure timely and
periodic payments as agreed to in the
contract.
• It will be advisable for the project manager to
appoint a „contract administrator‟ to manage
the total contract administration activities.
01/01/2010 532
Contract administration
• So, the duties of a contract administrator can
be derived as follows:
×Managing change;
×Ensuring that the vendor understands
specifications completely;
×Ensuring conformance to quality;
×Managing warranty on the products being
produced;
×Managing the sub-contractors under the
vendors;
01/01/2010 533
Contract administration
×Monitoring the manufacturing process;
×Handling deviations from the contract;
×Resolving conflicts;
×Managing payment schedules and contract
terminations.
• Job status: The info collected during the
project planning and implementation about
the jobs entrusted to the vendors –
completed, in process, their quality, the
expenditure incurred etc. gives the picture
about the job status.
01/01/2010 534
Contract administration
• Requisition for change: Any changes to be
made to the terms and conditions of the
contract or to the product or service
specifications are covered in the statement
for change request.
• Any performance of the vendor which is not
upto the mark may also be taken as a
change.
• But any disagreement between the vendor
and the project manager on accepting the
change can lead to conflicts and claims and
have to be resolved.
01/01/2010 535
Contract administration
• Vendor billing process: The vendor should
submit the bills at periodic intervals as per
the terms of the contract along with the
supporting documents for payments by the
project manager.
• Contract Closing: Is a process involving
verification of the product along with
updating all the project documents with the
final results and storing all project info for
future retrieval.
• This process may also form part of the
contract.
01/01/2010 536
Contract administration
• The process involves the following four
steps:
• Contract documentation – copy of contract,
changes requisitions, approvals vendor
performance reports, invoices and payment
records, contract related audits and
inspections……;
• Procurement audit : formal review of
procurement process;
• Contract files : total set of indexed
documents developed to include it in the
final project records;
01/01/2010 537
Contract administration
• Formal acceptance and closing: process
wherein the contract administrator submits a
formal written notice to the vendor saying that
the contract is complete.
• The contract administration may have the
authority (as per the contract terms) to decide
to close a contract at any time.
• If at the time of closing the contract, the
vendor has already incurred some
expenditure on the project, the project
manager may have to compensate the vendor
up to a certain amount as per the terms of the
contract.
01/01/2010 538
Contract administration
• The possible reasons for the project
administration to close the contract are:
– The product that was being procured is
not required any more;
– Technological advancement that can by-
pass the product requirement;
– Change in the allocation of funds;
– Availability of substitute products;
– Lack of profit expectancy;
– Failure to supply the product or service as
per the schedule;
01/01/2010 539
Contract administration
--Lack of progress in the activities of the
contract;
--Failure to stick to the terms and conditions
of the contract – deviation from the
contract in terms of quality and
performance standards.
• If there is a breach of contract on the part of
the vendor, the project administration may
not pay the vendor or even recover the
advance amount if given earlier.
01/01/2010 540
Contract administration
• If the contract is terminated, the contract
administrator has to check the breach of
contract and then decide to accept, partially
accept or reject the products/services
supplied by the vendor.
• He may then wait for some time to see if the
end products/services supplied by the
project are returned for rectification and if
so determine the monetary value of the
penalty to be charged to the vendor before
finally settling his account.
01/01/2010 541
Contract administration
• Thus, terminating a contract is one of the
challenging tasks of the contract
administrator.
• Project Inventory: The project materials
occupy a sizeable chunk of the total
materials required for a project.
• If the inventory is not properly handled, it
may result in shortage when needed and may
be available in plenty at other time,
occupying lot of space and precious working
capital.
• This will result in time and cost overruns.
01/01/2010 542
Project Stores Management
• Therefore the requirement of inventory
should be continuously monitored and
managed.
• “JIT”, the Just in Time strategy may be used
by the project to save in inventory holding
costs.
• Project Spares: Usually the OEMs provide
the list of recommended spare parts as well
as mandatory spare parts, which mostly the
project managers procure.
01/01/2010 543
Project Stores Management
• Among all the areas of Project management,
the warehousing of the project material
appears to be the most neglected, even though
a major chunk of the project investment is in
the material.
• In India, it is a common sight to see the project
machinery being stored in open grounds
gathering dust and rust till they are properly
erected.
• The responsibility of the stores manager is an
efficient, smooth running, economic operation
of the stores to give good timely service to the
project.
01/01/2010 544
Project Stores Management
• Obviously the stores manager requires
adequate space to store the materials and a
group of competent staff to handle them.
• The ill-effects of bad stores management:
Materials like cement or paint would harden;
• Iron and steel items would corrode;
• electronic instruments would be spoiled due to
humidity, heat and dust;
• fluids like petrol evaporate;
• materials containing wood get damaged by
white ants;
01/01/2010 545
Project Stores Management
• storage batteries getting damaged due to
humidity;
• Glass sheets stacked one over another
exposed to the sun crack;
• fire bricks disintegrate due to water;
• materials containing cloth and paper being
eaten away by rats and cockroaches
• and the list can go longer.
01/01/2010 546
Project Stores Management
• Thus the stores manager has to guard the
project materials from light, sun‟s rays, air,
heat, moisture, water, oils, dust, dirt, rats,
moths, white ants, fire, explosions, theft and
pilferages.




01/01/2010 547
Financing of the project
• A project may entail investment in : 
land,  plant and machinery,  other fixed
assets,  technical know-how, 
royalty,  advertisements, 
distribution network and  working capital.
• So, just like any corporate needs finance for
its various activities and plans the
appropriate structure of finance from various
sources, the project manager has also to do
the same exercise.
01/01/2010 548
Financing of the project
• So the questions that arise are:
What is the total cost of the project?
What should be capital structure? Which financing
instruments?
Whether the sources should be internal or external?
If external, whether it should be private or public
sources?
What should be the ideal cost of capital?
How much should be from short term and how much
from long term? etc.
01/01/2010 549
Financing of the project
• Preliminary and capital issue expenses;
• Pre-operative expenses;
• Margin money for working capital and
• Initial cash losses.
• The Means of Finance are as follows:
– Share Capital/reserves;
– Preference Capital;
– Private Equities/Venture Capital;
– Term Loans;
01/01/2010 550
Financing of the project
• Cost of the project comprises of the outlay
on account of:
• Land and site development;
• Buildings and Civil works;
• Plant and machinery;
• Technical know-how and engineering
fees;
• Expenses on foreign technicians and
training of Indian technicians abroad;
• Miscellaneous fixed assets;
01/01/2010 551
Sources of Finance
– Debentures;
– Deferred credits (from suppliers of plant
and machinery);
– Incentives and
– Other Miscellaneous sources (Unsecured
loans, public deposits, leasing and hire
purchase finance).
01/01/2010 552
Sources of Finance
• Planning the means of finance: The norms
prescribed by the regulatory bodies and the
financial institutions and the key business
considerations of the project sponsor have
to be kept in mind while planning the
structure of the means of finance.
• The norms of the regulatory bodies have the
interest of the investors as one of the
objectives.
• The norms of the financial institutions have
the safe return of their funds with interest as
their objective.
01/01/2010 553
Sources of Finance
• The project sponsor will have the following
factors in mind:
– cost of funds –cost of debt is cheaper due
to tax rebates on interest paid, whereas
dividend tax has to be paid on the
dividends paid out;
– Risk: Business risk arises from the
variability of earnings and the financial
risk arises from financial leverage i.e.
amount of debt;
– Control: the sponsors would like to have a
programme of financing which enables to
retain their control over the firm;
01/01/2010 554
Sources of Finance
– Flexibility: the structure of finance should
be such that the firm is able to borrow or
raise further capital in future if necessary.
• While discussing the capital structure it is
worthwhile to study the pluses and minuses
of equity and debt by comparing them:

01/01/2010 555
Equity Debt
Equity shareholders have a
residual claim on the
income and wealth of the
firm.
Creditors have a fixed
claim in the form of
interest and principal
payment.
Dividends paid is not tax
deductible
Interest paid by the firm is
tax deductible
Equity has an indefinite life Debt has a fixed maturity
Equity investors have the
right to control the affairs
of the firm
Debt investors play
passive role – apart from
imposing restrictions on
the way the firm is run, to
protect their interest
01/01/2010 556
Sources of Finance
• Thus, Equity is costlier but less risky,
whereas the debt is cheaper but more risky.
• In general, for tangible assets, debt finance
is used (since the lenders‟ comfort level is
more with the tangible assets) whereas for
intangibles, equity finance is preferred.
• Business Risk: - the variability of earning
power (=PBIT/total assets).
01/01/2010 557
Sources of Finance
• The factors that bring to bear business risk
are: Demand variability, price variability,
variability of input prices, and proportion of
fixed operating costs.
• The higher these variabilities and higher the
fixed cost, the higher is the business risk that
the firm would face.
• As a general rule, the combined business risk
and the financial risk should be manageable.
• A firm which facing more business risk
should try to reduce its financial risk and vice
versa.
01/01/2010 558
Sources of Finance
• Debt Equity norm of lenders: Lenders
normally permit the Debt/Equity norms up
to 1:1 but permit higher ratios up to 2.33:1
for capital intensive infrastructure projects
like power projects.
• Control considerations: Promoters who
want to retain control over the affairs of the
firm should have high proportion of equity.
• Market conditions: If the equity market is
active and buoyant, then the firm may get a
good premium for it‟s equity issues
whereas if the market is depressed, the firm
may go in for more debt.
01/01/2010 559
Sources of Finance
• Growth opportunities: When the firm has
good growth opportunities, the firm should
go for more equity whereas a firm which
does not have much growth opportunity
should go for debt.
• Public and private sources of capital: Debt as
well as equity can both be raised from public
(securities offered to public through „offer
documents‟ filed with the SEBI and made
available through secondary
markets)…………
01/01/2010 560
Sources of Finance
• ……as well as private sources (loans given
by banks, financial institutions, or issue of
equity/preference shares, debentures
privately placed with PE funds, VC firms, FIs,
Insurance cos., MFs, and HNIs.)
• Internal accruals: The internal accruals
consist of the non-cash charges like
depreciation and the retaining earnings.
• Retained earning is the (PAT minus the
preference and equity dividend minus
dividend tax paid.), which is ploughed back
in the firm.
01/01/2010 561
Advantages of
Internal Accruals
Disadvantages of Internal Accruals
Readily available to
the management for
use
The available amount may be limited
Eliminates issue
costs and losses on
account of under-
pricing
The opportunity cost of the retained
earnings is very high
No dilution of control Opportunity cost of depreciation
generated funds is the WACC.
Firms may underestimate the
opportunity cost of dep. Funds and
the retained earnings and
accordingly they may invest in
projects of low return leading to
destruction of shareholders‟ wealth.
01/01/2010 562
Sources of Finance
• Equity Capital: This is the capital collectively
owned by all the equity shareholders.
• They rank as the last claimants to the assets
of the firm and their liability is limited to the
extent of their shareholdings.
• In India, equity shares have a „par value‟ –
may be Re.1, Rs.2,4,5,10,20,50,100 or 1000 or
it may be any integer.
01/01/2010 563
Sources of Finance
• Even in the case of IPO (Initial Public
Offering –the first Public Issue of the Co.) or
any FPO (Follow on Public Issue – which are
subsequent Public Issues ), the shares may
be priced above the par value i.e. at premium
as per the advice of the Investment bankers
to the issue.
• In India, shares cannot be issued at discount
to the par values.
01/01/2010 564
Sources of Finance
• The equity shareholders have a right to
income from their investments, right to
appoint the Board of Director, have a right
for additional shares proportionate to their
existing holdings and the residual claims on
the assets of the firm on liquidation.
• However in reality, if a company has to be
liquidated, the equity shareholders may not
get anything.
01/01/2010 565
Sources of Finance
• In India, it has been observed that the
shareholders are indifferent and do not
exercise their power effectively, resulting
in the promoters holding the reins of
control, even if their holdings in the co.
may not be substantial.


01/01/2010 566
The advantages and disadvantages of the
equity capital are:

Advantages Disadvantages
No legal consequences
of skipping dividends. So
the co. need not pay
dividends if there are no
sufficient earnings or
when the profit is
required to be ploughed
back due to good
investment opportunities
Sale of equity dilutes
the control of the
existing
shareholders
01/01/2010 567
No maturity date and
hence the co. need not
redeem them
Rate of return required by
the equity investors is
generally very much
higher than the
requirement of the other
investors
The larger the equity,
the larger is the
capacity of the firm to
raise debt finance
Dividends are paid out of
PAT, whereas interest
payments are tax
deductible
Equity dividends are
exempt from income
tax at the hands of the
equity shareholders
Cost of issuing equity is
high due to underwriting
commission, brokerage
costs
01/01/2010 568
Sources of Finance
• Preference capital: - a hybrid instrument
having some characteristics of equity and
some of the debentures.
• Preference dividends are payable only out of
distributable profits but paid before the
equity shareholders are paid.
• The Preference dividend is not a tax
deductible payment for the company.
• Usually the preference dividend amount is
fixed and much lower than the rate of
dividend paid to the equity holders.
01/01/2010 569
Sources of Finance
• Preference equity holders do not have the right to
vote and their residual claim ranks above the equity
shareholders.
• There are different types of preference shares:
● Cumulative and non-cumulative preference
shares, ● participating and non-participating
preference shares, ● redeemable and non-
redeemable preference shares, and ● convertible
and non-convertible preference shares. (In India,
issue of Non-redeemable preference shares is not
permitted).

01/01/2010 570

Advantages and disadvantages of
preference capital:

Advantages Disadvantages
No legal
obligation to pay
dividends.
Since dividends paid to
preference share holders is
not tax exempt, it is costlier
than debt
No redemption
liability in the
case of non-
redeemable
preference
shares
Preference share holders‟
claim to the assets of the co.
are prior to the claims of the
equity share holders.
01/01/2010 571
Considered part of net
worth if redemption is
subordinated to debts
If the co. skips
preference dividends for
three years, voting
rights have to be given
to the preference share
holders
No voting rights and
hence no dilution of
control
Advantages and disadvantages of
preference capital……..
01/01/2010 572
Sources of Finance
• Debentures: Debenture is an alternative to
term loan. The Co. promises the debenture
holder to pay interest periodically at the
indicated rate and redeem the debenture on
the maturity date.
• The features of debentures are:
– A Trustee, usually a bank or a financial
institution or an insurance company is
appointed to take care of the interests of
the debenture holders to see that the co.
fulfils its contractual obligations.
01/01/2010 573
Sources of Finance
– Secured debentures are secured by
mortgages or charge on the immovable
properties and a floating charge on the other
assets. Debentures may also be unsecured.
– These are medium term (1 to 5 years) or
long term (more than 5 years) instruments
– Debentures for periods 18 months or above
have to be compulsorily rated
– For debentures of over 18 months DRR has
to be created and built up to at least 50%
before the redemption date.
01/01/2010 574
Sources of Finance
– They may carry fixed or floating rate of
interest (linked to a benchmark such as
the treasury bill) (or zero interest in the
case of deep discount bonds)
– They may have in-built features of „call‟
and „put‟ options in favour of the issuers.
– The interest paid on the debentures is a
tax deductible expense for the co.
– Debentures may be issued with the feature
of partial or full conversion facility at the
end of a certain predetermined period.
01/01/2010 575
Sources of Finance
– (Part or full amount of the Debentures are
converted into shares at the
predetermined premium)
– Convertible debentures are generally
popular since the interest payable on
them is lower than non-convertible
debentures and also lower than the bank
interest the co. would have paid for a bank
loan, and enables the co. to convert the
debenture amount into shares at premium.



01/01/2010 576
Sources of Finance
^Secured Premium Notes (SPNs): This is a
new instrument introduced by TISCO in 1992.
• This is akin to a debenture with the interest
payments staggered and paid along with part
of the principal, in four instalments at the
end of the 4th to 7th years. (FV Rs. 300.
Repayments at the end of 4th year to 7th year
: Rs. 75 towards principal + Rs. 75 towards
interest and a warrant of entitlement of one
share at Rs. 80 at the end of the 7th year.)
01/01/2010 577
Sources of Finance
• Indexed bonds: ICICI issued such bonds in
1997, each for Rs. 6000:
• It contained two parts – one was a deep
discount bond with redemption value of Rs.
22000/- at the end of 12 years.
• The second part was a small amount of Rs.
2000 the amount of repayment being
calculated as 2000*BSE sensex2000/BSE
Sensex1997.

01/01/2010 578
The advantages and disadvantages of
debt financing are:

Advantages Disadvantages
Interest paid on debt is
tax deductible expense
whereas dividends paid
on equity or preference
shares are paid out of
PAT
Failure to make the
timely interest and
principal repayments
may cause bankruptcy
of the firm
Does not result in
dilution of control
Increases financial
leverage and hence
according to CAPM
increases the cost of
equity
01/01/2010 579
Creditors entitled only
to the interest and
principal and not to the
value created out of the
debt
Debt covenants
impose restrictions
limiting the firm‟s
financial and
operating flexibility.
If there is a significant
decline in the value of
the firm, the
shareholders may
default on debt and
transfer the firm to the
creditors
If the rates of
inflation falls, then
the cost of debt
would prove to be
higher than
expected
The advantages and disadvantages of debt
financing are……:

01/01/2010 580
Issue cost of debt is very much
cheaper than that of
equity/preference issues
Since interest is fixed in nominal
terms, it protects the firm against
high inflation
Maturity of a debt instrument can
be adjusted to the needs of the
firm

The advantages and disadvantages of debt
financing are……:

01/01/2010 581
Sources of Finance
• Methods of offering: IPO/FPO/Bonds/Rights
Issues/Private Placements/Preferential
allotments.
• Private placement and preferential allotments
involve sale of securities to a limited number
of sophisticated investors like FIs, MFs, VC
funds, banks and so on.
• In a preferential allotment, the identity of the
investors is known when the co. approaches
the share holders for approval., whereas in the
case of Private placements, the identity of the
investors is not known when the offer
document is prepared.
01/01/2010 582
Sources of Finance
• In India Private placement refers to allotment
of securities of a listed or unlisted co.
Preferential allotment refers to allotment of
securities of a listed co.
• Pvt. Placements do not require registration
with SEBI.
• A „Private Placement Memorandum‟ is
prepared in place of the prospectus. In place
of road shows, the company hosts potential
investors‟ meet and gives presentation.
01/01/2010 583
Sources of Finance
• Generally preferential allotment is made to
promoters, strategic investors, VCs, FIs and
suppliers.
• The rationale for preferential allotment is to
secure the equity participation of those the
company considers desirable, but who may
otherwise find it very costly or impractical to
buy large chunks of shares in the market.


01/01/2010 584
Comparison of the various
methods of offering with each other:

Public
Issue
Rights
Issue
Pvt.
Placem
ent
Preferential
allotment
Amt. that can be
raised
Large Modera
te
Modera
te
Moderate
Cost of issue High Negligi
ble
Negligi
ble
Negligible
Dilution of control Yes No Yes Depends
Degree of under
pricing
Large Irreleva
nt
Small No
Market perception Negati
ve
Neutral Neutral Neutral
01/01/2010 585
Sources of Finance
• Term Loans: These are used to finance
acquisition of fixed assets and working
capital margin.
• Banks and FIs give rupee terms loans as well
as foreign currency term loans, for the
purpose of setting up new projects, or
expansion, modernisation or renovation of
existing of units.
01/01/2010 586
Sources of Finance
• FC loans are used for the import of plant,
machinery and equipment, payment of
foreign technical know-how fees etc.
• Repayment liability of principal and interest
remains in FC and converted into rupees at
the time of payment at the then ruling rates.
• The assets that are created out of the loan
form the main security for the loans and any
other securities may form the collateral
securities.
01/01/2010 587
Sources of Finance
• Usually, the term lending FIs which finance
the acquisition of fixed assets and the banks
which finance the working capital
requirements are in constant touch with
each other and coordinate the lending
activities, while monitoring the accounts of
the borrower.
• The FIs have the „first charge‟ over the
assets which they have financed and have
the „second charge‟ over the assets financed
by the banks.
01/01/2010 588
Sources of Finance
• The banks have the first charge on the
assets they finance and have the second
charge on the assets financed by the FIs.
• Thus all the assets of the firm are charged to
the lenders.
• There are three types of term lending
institutions:
• All India FIs: IFCI, EXIM Bank, IL&FS, PFC,
IDBI, IDFC,IIFCL, SIDBI, LIC, GIC. IDBI and
ICICI were in this category but have been
converted into banks.
01/01/2010 589
Sources of Finance

• State Level FCs: SIDCs and SFCs.
• Commercial Banks.: These banks do not
extend term loans for periods beyond 5-8
years normally, since their focus is on short
and medium terms.
• For term loans, the lenders also charge a
“processing fee‟ of about 1% of the loan
amount.
• There may be an initial repayment holiday, till
the project starts commercial production .
01/01/2010 590
Sources of Finance
• Thereafter the repayments of the principal
and interest due would begin at monthly,
quarterly or half yearly intervals depending
on the cash flows projected.
• Since the lending institutions will charge
penal interest on the „overdue‟ amounts (i.e.
the amounts of principal and or interest not
paid on due dates), the project manager has
to correctly calculate the cash outflows on
account of these dues.
01/01/2010 591
Sources of Finance
Usually the loan documents stipulate certain
covenants such as:
the board should have a nominee from the
lenders,
additional funds should be brought in by the
promoters in case of overrun;
bar to undertake any new project until the dues
are paid in full;
restrictions on transfer of shares of promoters
to others,
payment of dividends with the permission of
lenders etc.
01/01/2010 592
Sources of Finance
Procedure of sanction of term loan by the
FIs/banks:
Application by the co. in the lending
institution‟s standard form along with the
necessary enclosures like the Project Report,
Projected financial statements etc;
Initial processing by FI to check whether the
application is complete;
appraisal of the project;
01/01/2010 593
Sources of Finance
Procedure of sanction of term loan by the
FIs/banks:
Application by the co. in the lending
institution‟s standard form along with the
necessary enclosures like the Project Report,
Projected financial statements etc;
Initial processing by FI to check whether the
application is complete;
appraisal of the project;
Sanction of the proposal by the appropriate
authority and issue of the Sanction letter to
the co. along with the detailed list of terms
and conditions/covenants;
01/01/2010 594
Sources of Finance
creation of charges in favour of the lenders;
disbursement of the loans in stages as agreed
between the lenders and the co. depending
upon the projected cash flows;
and monitoring of the progress of the project
and recovery of the interest and principal.
• Depending on the size of the loan, more than
one bank/institution may participate in the
lending with a view to share the risk.
In such a case, the co. appoints one bank as
the „lead bank‟ , and prepares an „Information
Memorandum‟.
01/01/2010 595
Sources of Finance
The lead bank enlists the services of some other
banks in sharing the lending based on the
Information Memorandum.
This process is known as „Syndication‟
• Working Capital Advances: Used for financing
the current assets.
• In the pre-production stage, finance is given in
the form of Cash Credit/Overdraft/Letter of
Credit.
• Under the Cash Credit/Overdraft system, the
bank fixes the maximum amount that the co.
can draw for its operations, called the „limit‟.
01/01/2010 596
Sources of Finance
• Interest is charged periodically on the actual
amount utilised by the co.
• The operations are reviewed at the end of
every year and then renewed for another
year.
• In the case of loans, the limit amount
assessed for working capital needs of the
co. is given in the form of a loan and interest
is charged on the entire loan amount till it is
repaid.
01/01/2010 597
Sources of Finance
• In some cases, the supplier of RM may
demand an LC in which case the bank gives
the LC facility also to the co. as part of the
WC limits.
• LC is opened in favour of the supplier of the
RM, and on receipt of the stipulated
documents form the supplier, the bank pays
the supplier.
• The amount is then recovered by the bank
from the co.
01/01/2010 598
Sources of Finance
• In the post production stage, the co. sells its
products, raises bills on its customers, some
of whom avail some credit periods for
repayment.
• The bank discounts such bills on the co.‟s
debtors and credits the amount to the Cash
Credit/Overdraft account. Thus the cycle
goes on.
• There are other miscellaneous sources of
finance and they are:
01/01/2010 599
Sources of Finance
• Deferred credit: Suppliers of capital goods
usually offer long term credits.
• If the rate of interest loaded in the price is
less than the bank‟s rate, it would be
advantageous for the co. to avail the deferred
credit.
• However the supplier extending such
deferred credit is subject to a bank
guarantee, which would be part of the credit
facilities extended by the bank to the co.;
01/01/2010 600
Sources of Finance
• Lease and Hire Purchase finance; A Lease
finance represents a contractual
arrangement whereby the lessor grants the
lessee the right to use an asset in return for
periodic lease rental payments.
• Leasing of industrial equipments is a form of
debt finance. Two types of leases: Financial
and Operating leases:


01/01/2010 601
The differences between Leasing and
Hire Purchase is tabulated below:

Leasing Hire Purchasing
Lessee cannot claim
depreciation
Hirer is entitled to claim
depreciation
The entire lease rental
is a tax-deductible
expense for the lessee
Only the interest
component of the hire
purchase instalment is a
tax-deductible expense
The lessee not being
the owner does not get
the benefit of the
salvage value of the
asset
The hirer being the owner of
the asset, gets the benefit of
the salvage value of the
asset
01/01/2010 602
Sources of Finance
• Unsecured loans and deposits: These are the
loans provided by the promoters themselves or
their friends and relatives to make up the
shortfall of the required promoters‘ stipulated
contribution.
• These loans usually carry a rate of interest lower
than those on loans from the FIs, cannot be
repaid without the permission of the FIs and till
their loans are cleared.
01/01/2010 603
Sources of Finance
• Some well known companies prefer to collect
deposits from the public for periods depending
on their cash in flow, since the covenants that
apply to loans from FIs do not apply.
• However new companies may not be able to
raise such deposits since their track record is yet
to be built to attract the attention and confidence
of the public.
01/01/2010 604
Sources of Finance
• Special schemes of institutions: Sellers of
Capital equipments offer long term credits to
their buyers by obtaining their accepted Bills of
exchanges, discount them with their bankers
who in turn rediscount them with IDBI to
refinance themselves.
• ICICI operates a ―Suppliers‘ Credit‖ Scheme,
where the bank discounts the long term Bills of
exchanges of the sellers after they are accepted
by the buyers and co-accepted (‗avalised‘) by
their bankers.


01/01/2010 605
Sources of Finance
• Subsidies and sales tax deferments and
exemptions: Some states offer subsidies to
projects located in their states by giving them a
sizeable amount of the project cost say even
upto 25% subject to a certain maximum
amount.
• In addition some states offer sales tax
exemptions (on materials purchased from the
state) and deferments for a few years.
• The deferments are equivalent to interest free
loans.
01/01/2010 606
Sources of Finance
• Short term loans from financial institutions :
Companies with good financial track records are
offered short term – one year—loans without any
securities for tiding over their financial difficulties.
These are called ‗Corporate loans‘.
• Commercial papers: Companies with good credit
rating may issue CPs which are unsecured
promissory notes for periods not more than six
months.
• These are sold at discounts to the face values and
redeemed at their face values, the discount
representing the interest on the CPs. (See RBI‘s
website for the latest guidelines
:http://www.rbi.org.in/scripts/BS_ViewMasterCircular
s.aspx?Id=4285&Mode=0)
01/01/2010 607
Sources of Finance
• Factoring: ‗Factors‘ are FIs which extend
finance upto 80% of the receivables of their
customers and also manage the receivables.
• SBI Factors, Can Factors, PNB Factors and
Allahabad Factors have been authorised by
RBI to serve the western, southern, northern
and eastern parts of India.
• Securitisation: It is a method adopted to liquefy
the assets of a firm which has got receivables.
• The assets are bundled, rated and then
securities are issued to the investors giving
them the bundle of securities as collateral
securities.
01/01/2010 608
Sources of Finance
• The pool of securities are normally transferred to
an SPV which holds the securities in trust for the
investors for which service, the SPV is entitled
for an appropriate fee.
• The securities are called Pass Through
Certificates (PTCs).
• The pool may be divided into different classes
depending on their rating and the PTCs may be
issued against each distinct rated class of
securities.
01/01/2010 609
Sources of Finance
• Obviously the PTCs issued against the best
rated securities will carry the least rate of
interest and will be redeemed first.
• Raising Venture Capital: If a co. which is not yet
known to the public cannot approach them with
the offer of a Public Issue to raise finance for its
needs.
01/01/2010 610
Sources of Finance
• The Venture Capitalists (VCs) study the
entrepreneur‘s and his business‘s potential to
satisfy themselves that the entrepreneur‘s
management team is capable, talented,
experienced, committed and determined and
then invest in the co.
• After a few years, the VCs exit the co. by
divesting through ‗Offers‘ to retail investors at
premium or to other entrepreneurs with a good
margin of profit.
01/01/2010 611
Sources of Finance
• Raising Capital in the international markets: Due
to the globalisation of the Capital markets, an
Indian entrepreneur can now approach off-shore
markets, or markets in other countries for raising
capital (ADRs, GDRs) or borrowing (syndicated
loans) or issue bonds (FRNs, RUFs) in any
currency.
• The RBI has issued detailed guidelines about the
External Commercial Borrowings (ECBs) --about
the eligibility of the borrowers, limits of borrowing,
maximum rate of interest outflow etc., .Look up for
the same in their website:
http://www.rbi.org.in/scripts/BS_ViewMasterCircul
ars.aspx .
01/01/2010 612
Sources of Finance
• Evaluation of overseas debts: Overseas debt,
especially the Eurocurrency loans offers the
following advantages:
– Participating institutions have a very
professional approach and have huge funds
at their disposal to give loans of any
amounts;
– A lot of flexibility is availability in structuring
the loans;
– Tenors of the loans may go even up to 10
years;
01/01/2010 613
Sources of Finance
• The disadvantages are :
--ECBs are not economical for small projects due
to costs involved for appraisal and syndication;
– Interest rates charged depends on the risk
perception of the lender/lead lender;
– May be difficult to negotiate with the investors.
01/01/2010 614
Sources of Finance
• Global Deposit Receipts (GDRs) : These are
indirect equity investments issued in $s in the
Euromarkets.
• The shares issued by the co. are held by a
depository, usually a large international bank
which receives all the benefits of the underlying
shares and distributes to the holders of the DRs.
• Each DR represents a certain number of shares.
These GDRs are listed and traded in major
stock exchanges in Europe.
01/01/2010 615
Sources of Finance
• The issuer pays dividends in the home
currency to the Depository which is converted
into $s and paid by the Depository to the
holders.
• The holders of the GDRs can convert the DRs
into shares at any time by surrendering them to
the Depository.
• Since GDRs are FDIs, appropriate permission
has to be obtained from the FIPB and RBI.
• American Depository Receipts (ADRs): ADRs
are similar to the GDRs except for the fact that
they are listed in the Stock Exchanges in the
USA and attract more stringent disclosure
conditions imposed by the SEC.
01/01/2010 616
Sources of Finance
• Foreign Domestic markets: Another way to raise
money internationally is to sell securities
directly in the domestic capital markets of foreign
countries.
• Example would be an Indian co. issuing
securities in $s in the capital markets of USA.
• (Indian cos. have already tapped the US,UK,
Japan and Switzerland markets.)
• The foreign issuer has to satisfy all regulations
applicable to the domestic firms. There may be
in fact additional obligations to be fulfilled by the
foreign issuers.
01/01/2010 617
Sources of Finance
• The US Capital Market is the largest with a very active
derivatives market also.
• Under Rule No. 144A under the Securities Act of 1933,
Yankee bonds can be issued to QIBs without much
restrictions which are applicable to the securities issued
to the general public.
• (Yankee bonds are bonds issued in $s in USA by issuers
of other countries.
• Similarly Bull Dogs, Samurais and Matilda or Kangaroos
are bonds issued in Stg. Pds., Japanese Yen and
Australian $s in the respective countries by issuers of
other countries.)

01/01/2010 618
Sources of Finance
• Export Credit Schemes: The Governments of a
number of countries like US, Japan and India
have created ‗EXIM‘ banks for financing exports
of capital goods and related technical services.
• Under the ‗Berne Union‘ conventions, the EXIM
banks‘ interest rates applicable for export credits
to Indian companies are regulated.
• Both Buyers‘ credits as well as Suppliers‘ credits
are provided.
01/01/2010 619
Sources of Finance
• Buyers‘ Credits: Under this Scheme, credit is
provided directly to the Indian buyer of capital
goods/technical services from the overseas
exporter.
• The steps involved in this process are:
• The overseas exporter and the Indian buyer
negotiate the contract;
• Application for the Buyer‘s credit is submitted to
the Export Credit Agency of the exporter‘s
country; processed by the agency and is
approved;
01/01/2010 620
Sources of Finance
• The loan agreement containing the terms and
conditions of the buyer‘s credit is negotiated
between the exporter‘s bank and the Indian
borrower (and the guarantor if any of the Indian
borrower) and entered into.
• Suppliers‘ Credit: This is a credit provided to the
overseas exporters so that they can make
available medium term finance to Indian
importers.
01/01/2010 621
Sources of Finance
• The steps involved in the process are:
• The overseas exporter notifies his bank and the
export credit agency of a potential export order
from an Indian buyer, requiring medium term
finance;
• The export credit agency communicates its
willingness to provide the facility;
• The terms of the facility are incorporated in the
contract between the overseas exporter and the
Indian buyer.
01/01/2010 622
Sources of Finance
• The salient features of the finance provided by
the export credit agencies are:
• The finance is tied to import of goods and
services;
• Up to 85% of the value of imports is available as
finance;
• Finance available for long tenors at reasonable
cost;
• Finance is provided against the guarantees of
the buyer‘s bank (in the case of buyer‘s credit)
and the seller‘s bank (in the case of seller‘s
credit).
01/01/2010 623
Sources of Finance
• Project financing structures: Full recourse
structure and Limited recourse structure:
• Full recourse structure: The features are:
• If the project is implemented by a new company,
the borrowings of the co. are backed by charge
on all the existing and future assets of the co.
• If an existing co. borrows for a new project, then
the new lender gets a ‗pari-passu‘ charge over
all the existing and future assets of the co. along
with the other lenders.
01/01/2010 624
Sources of Finance
• The viability of the project would be assessed on
a stand-alone basis but the stand alone cash
flows as well as the total cash flows of the
company are taken into account to judge
whether the company would be in a position to
service the existing as well as the proposed
debts.
• In addition to the above charges, the lenders
sometimes insist on the personal guarantee of
the promoters also and a corporate guarantee of
one of the group companies.
01/01/2010 625
Sources of Finance
• Limited recourse structure: Of late private
participation in infrastructure projects is
increasing. The salient features of the structure
are:
• The project is set up as a separate company as
an SPV;
• The pvt. sector promoter usually takes a major
stake in the equity of the project and enjoys the
over-all responsibility for running the project;
01/01/2010 626
Sources of Finance
• The pvt. sector promoter provides stand-by
support for cost overruns if the quantum of such
support is crystallised before the financial
closure;
• The cash flow of the SPV is handled by a Trust
or in an escrow account for appropriating the
cash flows in the predetermined manner for
various requirements of the project as well as
debt servicing. After all the requirements are
met, the residual cash flow is available to the
project company.
01/01/2010 627
Sources of Finance
• In some cases, the government guarantee may
be available;
• Lenders do not have recourse to the sponsors
and their other assets.
• Financial closure: Financial closure means that
all the sources of funds for the project have been
tied up.
• Generally in the case of infrastructure projects,
financial closure takes more time since the
lenders have to satisfy themselves about all the
issues concerned before committing their funds.
01/01/2010 628
Sources of Finance
• In general, financial closure can be achieved
early if:
• Suitable credit enhancements (additional
securities) are done to the satisfaction of the
lenders;
• Underwriting arrangements are made for market
related securities offerings;
• The credit worthiness and reputation of the
sponsors is well established and
• The proposal is simultaneously processed by all
the proposed lenders and coordinated among
themselves.
01/01/2010 629
Cost of Capital
• The cost of capital assumes significance since:
• The project has to earn an IRR which can
satisfactorily meet the cost of the funds obtained
for financing the project.
• It is used as the discount rate to determine the
NPV of the project or the cut-off or the hurdle
rate with which to compare the IRR.
• Understanding of the cost of capital is essential
to take the correct decision about the LT as well
as ST borrowings, leasing etc.
01/01/2010 630
Cost of Capital
• Where different sources of funds are employed,
the project financing mix has to be adjusted in
such a manner as to result in as low a cost of
capital as possible.
• Composite Cost of Capital: When the firm gets
its LT funds from different sources, the weighted
arithmetic average of the cost of the different
sources constitutes the firm‘s cost of capital.
01/01/2010 631
Cost of Capital
• Let us take a simple example: A firm has 30%
equity with cost of equity at 20% and LT debt of
70% with cost of debt at 15%. Then the
composite cost of capital would be: (0.3*0.2%) +
(0.7 * 0.15%) = 16.5%.
• By extending the number sources of finance to
n, the composite cost of capital =
p
1
k
1
+p
2
k
2
+……+p
n
k
n
, where p
1
, p
2
…p
n
are the
proportions of the first, second…nth source and
k
1
, k
2
….k
n
are the costs of the first, second…nth
sources of finance.
01/01/2010 632
Cost of Capital
• If a combination of equity, retained earnings,
preference shares and debt is considered, the
formula can be restated as follows:
• K
0
= w
1
k
e
+w
2
k
r
+w
3
k
p
+w
4
k
d
,
where K
0
,, k
e
, k
r
, k
p
and k
d
are the Composite
cost of capital, cost of equity, cost of retained
earnings, cost of preference equity and cost of
debt respectively and
w
1
, w
2
, w
3
, w
4
are the respective weights
representing the proportion of capital from the
concerned source , to the total capital employed.
01/01/2010 633
Cost of Capital
• See some examples in the notes.
• Since project financing concerns the present
and the future transactions of raising equity or
contracting debts, we should consider the
marginal cost of the specific sources of
financing we are selecting and not the
weighted average of the existing mix of
finance.
• Cost of equity capital: It is the minimum rate
of return that is expected on the equity
financed portion of its investments in order to
keep in tact the market price of the firm‘s
stock.
01/01/2010 634
Cost of Capital
• Some of the methods of computation of the
cost of equity are : Historical rates of return;
CAPM and Dividend growth model.
• In the Historical Rate of return approach, the
past rate of earnings on equity is taken as the
basis for determining the future cost of equity
capital.
• The CAPM, as a framework for investment
projects, implies that projects should be
judged with reference to their systematic risk.
01/01/2010 635
Cost of Capital
• The appropriate discount rate for the project is
given by the formula:
K
i
= R
f
+ β
i
(k
m
– R
f
) :where K
i
= rate of return
required on equity, R
f
= Risk free rate of
return, β
i
= beta of security and k
m
=
rate of return on the market portfolio.
• Dividend Growth Model: In this model, the cost
of equity will be the market rate of discount that
equates the present value of all anticipated
future dividends with the prevailing price of the
stock.
01/01/2010 636
Cost of Capital
• If dividends are expected to grow at a
constant rate g, and the cost of equity k
e
>g,
the cost of equity is given by the equation:
K
e
= (D
1
/P
0
) + g, where D
1
= the dividend
that is expected to be paid at the end of
period 1 and P
0
is the value of a share of
stock at time 0.
• For example, if a company expects to pay a
dividend of Rs. 15 per share at the end of
period 1, and that the co‘s earnings and
dividend per share are expected to
grow………
01/01/2010 637
Cost of Capital
• ……. at 3% in line with the growth in the
economy and the current price of the share is
Rs. 180, the cost of equity capital will be : k
e

= (15/180) + 0.03 = 11.33%
• (If constant growth rate in the dividend cannot
be assumed , and a tapering off of the growth
rate is anticipated, the equation can be
modified to incorporate such deviations, if they
are defined in terms of the time frame and
quantum.) .
• Whatever be the model, the measure of cost of
equity would only be an approximation and not
precise.
01/01/2010 638
Cost of Capital
• Factors affecting the weighted average cost of
capital: The WACC is affected by several factors,
some of which are dependent on the investment
and financing policies of the co. and some are
beyond the control of the co.
• The factors which depend on the co.‘s policies
are :
• Investment policy (If the riskiness of the proposed
investment is different from the riskiness of the
existing investments, then the marginal cost of
capital would reflect the riskiness of the proposed
investments.)
01/01/2010 639
Cost of Capital

• Capital Structure Policy: Since the post tax cost of debt
is cheaper than the cost of equity, the co. may adopt the
appropriate level of financial leverage.
• Dividend Policy.
• The level of interest rate : Depending on the prevailing
levels of interest, the cost of debt and preference capital
may change. Even the cost of equity will depend on the
levels of interest rate since it affects the risk free interest
rate.
• Market risk premium : This is the perceived risk of equity
stocks.
• Tax rates.
01/01/2010 640
Cost of Capital
• Cost of Debt : The after tax cost of debt is
the discount rate which equates the net
proceeds of the debt issue with the present
values of the outflows in the form of interest
and principal repayments, adjusted for the tax
effect. The equation is :
k
i
= k(1-t), where k
i
= the net proceeds of the
debt issue, k is the IRR or yield and t
represents the tax rate.
• If interest is paid annually and redemption at
maturity, the equation will become:……

01/01/2010 641
Cost of Capital
n
• P =  C (1-t) + F ,
t = 1 (1 + k
d
)
1
(1 + k
d
)
n
where P = net proceeds of the debt issue, C =
Interest per annum, t = tax rate, F =
redemption price, n =
maturity period of debt.

01/01/2010 642
Cost of Capital
• Cost of preference capital: The case of
redeemable pref. capital is similar to debt, the
difference being pref. dividend is paid instead of
interest, tax is not applicable and the
discounting rate is k
p
the cost of pref. capital
instead of k
d
the cost of debt.
• So the equation is:
n
P =  D + F . , where..
i = 1 (1 + k
p
)i (1 + k
p
)
n
01/01/2010 643
Cost of Capital
• P = net proceeds per pref. share, D= pref.
dividend per share payable annually, F =
redemption price, k
p
= post tax cost of debt and
n = maturity period of pref. share.
• The approximate cost of preference capital is
given by the equation:
k
p
= D + (F-P)/n
(P + F )/2
01/01/2010 644
Cost of Capital
• For example, if a company issues pref.
shares of face value Rs. 10 with a
dividend of 10%, redeemable after 10
years, and the net amount realised per
share is Rs.9.50, the cost of pref. share
capital will be:
10 + (10-9.50)/10 = 10.05 = 10.31%
(10 + 9.50)/2 9.75

01/01/2010 645
Cost of Capital
• Financing of project expansion: A new project
may be implemented as a division of the parent
co or it may be implemented through a separate
company.
• If implemented as a division of the co., then the
internal resources of generated by the co. can
be partly used as it may not be sufficient.
• The other sources are unsecured deposits from
the public, term loans, and issue of capital or
debentures.
01/01/2010 646
Financial Institutions- IFCI
+Financial institutions may be broadly categorised
into two categories: All India financial Institutions
and State Level FIs.
• The All India FIs are:
●IFCI: IFCI offers the following wide range of
products.
• Short-term Loans (upto two years) for different short
term requirements including bridge loan, Corporate
Loan etc
• Medium-term Loans (more than two years to eight
years) for business expansion, technology up-
gradation, R&D expenditure, implementing early
retirement scheme, Corporate Loan, supplementing
working capital and repaying high cost debt .
01/01/2010 647
IFCI
• Long-term Loans (more than eight years to upto
15 years) - Project Finance for new industrial/
infrastructure projects, ‗Takeout Finance‘,
acquisition financing (as per extant RBI
guidelines / Board approved policy), Corporate
Loan, Securitisation of debt
• Structured Products: acquisition finance, pre-
IPO investment, IPO finance, promoter funding,
etc.
• Lease Financing
• Takeover of accounts from Banks / Financial
Institutions / NBFCs.
01/01/2010 648
IFCI
• Financing promoters‘ contribution (private equity
participation)/subscription to convertible warrants
• Purchase of Standard Assets and NPAs
• IFCI customizes the product-mix to suit the
business/industry.
• Targeted Business Segments:
IFCI has been meeting the changing requirements
of the clients through financial products for
multiple industry sectors.
• Major Financing Schemes of IFCI includes Project
Financing and Financial Services mainly to the
manufacturing industry along with a diversified
industrial portfolio.
01/01/2010 649
IFCI
• Public Sector Undertakings
• Manufacturing industry
• Infrastructure projects
– Power
– Airports (brown field)
– Ports
– Hotels
– Urban infrastructure projects
• NBFCs
• Participation in Private Equity
– Promoter funding
01/01/2010 650
IFCI
• Corporate Advisory Services
• Corporate advisory & infrastructure services
• Infrastructure advisory
• Monitoring agency for public issues
• Restructuring advisory services
• Bid process management
• Corporate advisory & infrastructure services:
India is throwing up investment avenues in
newer sectors and projects, and IFCI fills up the
critical need to provide specialised advisory
services to the Indian Corporate Sector in their
efforts towards Industrial Advancement.
01/01/2010 651
IFCI

• As a catalyst of Industrial growth, IFCI provides the
following Advisory Services:
• Investment appraisal of Navratna (most valued
public sector companies) Companies.
• Project Conceptualization and related services,
including Guidance in relation to Selection of
Projects, Preparation of feasibility studies, DPR,
Capital Structuring, Techno-economic Feasibility,
Financial Engineering, Project Management Design
etc.
• Credit Syndication including preparation of
Information Memorandum, Syndication of
domestic/foreign loans, Post Sanction follow-up,
Assistance in legal documentation etc.
01/01/2010 652
IFCI
• Documentation of various project documents.
• Infrastructure advisory:
• IFCI offers a range of services to the
Infrastructure Sector, with specific emphasis on
roads, ports, power and urban infrastructure -
total solutions starting from the stage of
investment identification to financial closure are
provided.
• The services provided in the Infrastructure
Sector include:
• Facilitation of Credit Documentation.
• Due Diligence.
01/01/2010 653
IFCI
• Agreements & Document Review/Advice.
• Pre-Investment Review.
• Project Conceptualization and Feasibility
Studies.
• Risk Allocation, Assessment & Reasonableness
of Cost.
• Advise on Financing Options – Sources, Cost &
Risk.
• Financial Analysis & Modeling – Scenario
Analysis.
• Potential JV/Partner Profiling.
01/01/2010 654
IFCI
• Negotiating Support for Equity Buy In.
• Project Evaluation.
• Credit Syndication – Domestic & Overseas.
• Arranging Deferred Payment Guarantee, ECB.
• Placement of debt & equity.
• Capital Market Advisory Services.
• As per the SEBI (Disclosure & Investor
Protection) Guidelines, 2000, in case of issues
exceeding Rs.500 crore, the issuer shall make
arrangements for the use of proceeds of the
issue to be monitored by one of the financial
institutions.
01/01/2010 655
IFCI
• IFCI offers its services as Monitoring Agency for
the same:
• Carrying out of Post-Issue due diligence;
• Ascertaining whether the utilization of issue
funds has been made for the purposes and in a
manner as envisaged by the Offer Document;
• Preparation of Monitoring Report as per the
format specified at Schedule-XIX of the above
guidelines;
• Submission of the report to the SEBI on a half-
yearly basis, till the completion of project, for the
purposes of record.
01/01/2010 656
IFCI
• Restructuring advisory services:
• Advisory Services to corporate and government
clients comprising financial restructuring,
operational restructuring, cost-structure studies
and process analysis & improvement:
• Organizational Structural Changes
• Analysis of the Operational Performance.
• Study of the Existing Organizational Structure.
• Study of the Existing Statutes & Rules and
Regulations.
• Market Analysis with respect to products.
01/01/2010 657
IFCI
• Review of the Domestic & International
Scenario.
• Valuation of Fixed Assets and Inventory.
• Advising on Formation of New Entity.
• Preparation of relevant Agreements/ Legal
Documents.
• Buy/Sell Advisory
• Purchase, sale, transfer of assets, operating and
technology rights, brands, business operations,
divisions and corporate entities.
• Separation, liquidation, disposal of non-strategic
ventures, assets or liabilities.
01/01/2010 658
IFCI
• Mergers, Joint Ventures and Alliances
• Drafting information memoranda for potential
buyers/ sellers.
• Locating suitable counter-parties.
• Assessing and advising on augmenting the
viability.
• Determining of share exchange ratio.
• Structuring and negotiating of terms and
conditions for the new entity.
• Managing and monitoring of the documentation,
transaction and transition process.
01/01/2010 659
IFCI
• Privatisation
• Conducting the SWOT Analysis and based on
the same, to prepare an appropriate package.
• Assessment & Valuation of assets.
• Valuation of company as a going concern.
• Suggesting measures to enhance sale value.
• Financial restructuring, if any.
• Preparation of Information Memorandum.
• Bid process management:
• IFCI has successfully handled several Bid
Process Management Assignments.
01/01/2010 660
IFCI
• IFCI offers a range of services under the Bid
Process Management: -
• Preparation of Bid Documents (for various
modes of Bid process) and Advertisement
inviting Expression of Interest (EOI);
• Evaluation of Bids and Assisting till the final
award of Contract.
• It provides long term finance to the industries
and issues guarantees on their behalf. It also
has soft loan schemes and provides Risk Capital
Assistance sponsored by the Risk Capital and
Technology Finance Corporation Ltd.
01/01/2010 661
ICICI, IDBI
● ICICI: It has been specialising in providing term
loans in foreign currencies, extending
underwriting assistance and issuing guarantees.
● It also grants rupee loans and has a Merchant
Banking Cell to give specialised services in
project planning and formulation.
●IDBI: Under the Project Finance scheme IDBI
Bank provides finance to the corporates for
projects in both rupee and foreign currencies for
Greenfield projects as also for expansion,
diversification and modernization.
01/01/2010 662
IDBI
● IDBI Bank follows the Global Best Practices in
project appraisal and monitoring and has a well-
diversified industry portfolio.
●IDBI Bank has signed a Memorandum of
Understanding (MoU) with LIC in December
2006 for undertaking joint and ‗take-out‘
financing of long-gestation projects, including
infrastructure projects.
● IDBI Bank has been actively participating in
structuring and financing of infrastructure
projects in the areas of power, telecom, roads,
seaports, railways and logistics as well as
Special Economic Zones.
01/01/2010 663
IDBI
●The Bank has also taken initiatives in funding
modernization of airports, besides part-financing
development of international airports and
seaports under the Public-Private Partnership
route.
●The Bank is also a member of the Core
Committee of the Government set up for
finalisation of the Ultra Mega Power Projects
(UMPPs).
● IDBI Bank interacts with Government and other
stakeholders and market participants, on policy
and operational issues, facilitating smooth flow
of funds to infrastructure sector.
01/01/2010 664
IDBI
●It operates Bill discounting and technical
development fund schemes.
● It also augments the funds of the State level
financing institutions by subscribing to their
bonds.
● IDBI has a Bill discounting scheme through
which it provides refinance assistance to SSFCs,
SIDCs and commercial banks.
• UTI, GIC, LIC: They assist industrial projects by
mainly participating in consortium arrangements
for providing equity support and underwriting
assistance and granting term loans.
01/01/2010 665
IIBI, SIDBI
• Industrial Investment Bank of India (IIBI)
(Formerly Industrial Reconstruction Bank of
India –IRBI): It specialises in providing
rehabilitation assistance to sick units.
• National small Industries Corporation (NSIC),
• SIDBI: It takes care of the needs of the Small
Scale and SME sector industries.
• The State Level FIs are: SFCs and SIDCs.
01/01/2010 666
IDFC
• Infrastructure Development Finance Co. Ltd.
(IDFC):
• (For more details pl. see
http://www.idfcpe.com/pages/main1.html and
http://www.idfc.com )
• IDFC‘s mission is to be the financier of and
advisor of choice for infrastructure in India.
• It is focussed on growing its balance sheet
through project finance, and building up
innovative fee based business from asset
management, project development and advisory
services.
01/01/2010 667
IDFC
• IDFC finances projects for electricity generation,
transmission and distribution, as well as projects
in the oil and gas industry.
• The other sectors financed by IDFC are in the
urban infrastructure development - urban
transportation(-roads, ports, airports, railways
and pipelines),
• solid waste management,
• industrial water supply,
01/01/2010 668
IDFC
• telecommunications (cellular, basic, long
distance and international and cable -- new
projects and acquisition finance for
consolidation),
• tourism, SEZs, townships, IT parks, and
• commercial and retail real estates
• Under the ‗viability gap funding‘ mechanism
announced by the GOI, whereby the GOI funds
upto 20% of the project cost under the Public
Private Partnership model, the IDFC funds the
private sector entrepreneurs for projects in the
above mentioned areas.
01/01/2010 669
IDFC, IIFCL
• IDFCPE ( a 100% subsidiary of IDFC) was
established in 2002, is India‘s largest and most
actives Private Equity focussed on infrastructure
and is managing a corpus of Rs. 57.2 billion.
• India Infrastructure Finance Company Ltd
(IIFCL) :
• Although there has been progress in attracting
private investments into infrastructure, Gross
Capital Formation (GCF) in infrastructure has
hovered around 5 percent of Gross Domestic
Product (GDP)
01/01/2010 670
IIFCL
• The 11th Five Year Plan (2007-2012) has
envisaged raising the level of GCF in infrastructure
to 9 percent of GDP by 2012 , thereby matching
the levels obtaining in some of the Asian
economies.
• Government of India, accordingly approved a
Scheme for Financing Viable Infrastructure
Projects through a Special Purpose Vehicle called
the India Infrastructure Finance Company Ltd,
broadly referred to as SIFTI.
• Accordingly, India Infrastructure Finance Company
Ltd (IIFCL) was established in January 2006 as a
wholly owned Government of India company and
commenced its operations from April 2006.
01/01/2010 671
IIFCL
• IIFCL shall finance only commercially viable
infrastructure projects. In order to be eligible for
funding by IIFCL, the following will be the eligibility
criteria:
• Eligibility
• The project shall be implemented by : A Public
Sector Company ;  A Private Sector Company
selected under a Public-Private Partnership (PPP)
initiative  a private sector company provided it
has undertaken a project where the service to be
provided is regulated or the project is being set up
under an MoU arrangement with the Central, any
State government or a Public Sector Undertaking.
01/01/2010 672
IIFCL
 Total lending for such private projects shall not
exceed 20% of the lending programme of the
company in any accounting year  The tenor of
IIFCL lending should be larger than that of the
longest tenor commercial debt by at least two
years. The project should be from one of the
following sectors : Roads and bridges, railways,
seaports, airports, inland waterways, other
transportation projects; Power; Urban transport,
water supply, sewage, solid waste management
and other physical infrastructure in urban areas;
Gas pipelines Infrastructure projects in Special
Economic Zones (SEZs) and International
Convention Centres and other tourism
infrastructure projects.
01/01/2010 673
IIFCL
• Projects which are set up on ―non-recourse‖
basis would only be eligible for financing by
IIFCL.
• Disbursement of loans by IIFCL is subject to the
appraisal being done by reputed appraising
institutions and the lead bank accepting and
adopting the same.
• IIFCL shall disburse the loan only after getting
the sanction from the Lead Bank.
• IIFCL would not normally carry out any
independent appraisal of the project.
01/01/2010 674
IIFCL
• Lead Bank shall be responsible for regular
monitoring and periodic evaluation of
compliance of the project with the agreed
milestones.
• Lending Terms:
• IIFCL may fund viable infrastructure projects
through the following modes:
• Long term debt; Refinance to banks and
financial institutions for loans with tenor of more
than 10 years granted by them; Any other mode
approved by Government of India.
01/01/2010 675
IIFCL
• Total lending to any project by IIFCL shall not
exceed 20% of the total project cost subject to
exposure of IIFCL being less than that of the lead
bank.
• Lending to PPP projects
• A project awarded to private sector company
through PPP shall be accorded priority for lending
by IIFCL.
• A PPP project has been defined under the
Scheme as a project based on a contract or
concession agreement between a government or
a statutory entity on the one side and a private
sector company on the other side, delivering an
infrastructure service on payment of user charges.
01/01/2010 676
IIFCL
• In case of PPP projects, the private sector
company shall be selected through a
transparent and open competitive bidding
process.
• PPP projects based on standardized/model
documents duly approved by the respective
government would be preferred.



01/01/2010 677
General: All India Financial Institutions
• In general, the wide range of categories of
financial Assistance given by the all India FIs
are:
• × Rupee Term Loans; × Foreign Currency
Term Loans; × Underwriting of equity capital,
Preference Capital, Debentures and bonds;
×Direct subscription to Capital; × Guaranteeing
loans raised by industrial concerns from different
sources including commercial banks and
extending guarantees in respect of deferred
payments by importers; × Bill rediscounting; ×
Operation of Technical Development Fund; ×
Soft Loan Schemes; × Equipment Financing; ×
Lease Financing; × Seed Capital Assistance;
and ×Risk Capital Assistance.
01/01/2010 678
SFCs, EXIM Bank
• The financial assistance provided by the
State Level Corporations are:
• × Term Loans; ×Underwriting of shares
and ×Direct subscription to capital.
• Exim Bank : Backs up the exporter of
Project exports, every step.
● From identifying global opportunities,
preparing competitive bids, to guarantees
and financial support, till the projects are
successfully completed.
01/01/2010 679
EXIM Bank
●From power generation, transmission &
distribution, dams, tunnels, oil exploration, to
supply of capital goods and consultancy
services, the range is wide.
(More details are available in Exim Bank‘s
website under Lines of Credit.)
● The programmes of lending are under the
Suppliers‘ Credit to the Indian Exporter, under
the Buyers‘ Credit to the buyer of Indian
goods/projects, and under the Lines of Credit to
the foreign governments, FIs and banks.
01/01/2010 680
NABARD
• NABARD extends credit to agriculture, allied
small-scale industries, cottage and village
industries, and handicraft and allied activities.
● It also refinances the commercial banks against
their lending to these sectors.
● It gives expert advice on projects formulation,
implementation etc. to the sponsors of projects
in the above areas and also refinances banks
which gives such project loans.








01/01/2010 681
International Financial Institutions- IFC
• International Finance Corporation (IFC), a
member of the World Bank group:
• Products & Services:
• IFC is a dynamic organization, constantly
adjusting to the evolving needs of its clients in
emerging markets. Apart from Project Finance to
companies in developing countries, it also has:
• Developed innovative financial products
• Broadened its capacity to provide advisory
services.
01/01/2010 682
IFC
• Financial Products:
IFC continues to develop new financial tools that
enable companies to manage risk and broaden
their access to foreign and domestic capital
markets. Its financial products include:
• Loans for IFC's Account
• (IFC offers fixed and variable rate loans for its
own account to private sector projects in
developing countries. These loans for IFC's own
account are called A-loans.)
• Most A-loans are issued in leading currencies,
but local currency loans can also be provided.
01/01/2010 683
IFC
• The loans typically have maturities of 7 to 12
years at origination.
• Grace periods and repayment schedules are
determined on a case-by-case basis in
accordance with the borrower's cash flow needs.
• If warranted by the project, IFC provides longer-
term loans and longer grace periods.
• Some loans have been extended to as long as
20 years.
• IFC operates on a commercial basis. It invests
exclusively in for-profit projects and charges
market rates for its products and services.
01/01/2010 684
IFC
• Loans from IFC finance both greenfield
companies and expansion projects in developing
countries.
• The Corporation also makes loans to
intermediary banks, leasing companies, and
other financial institutions through credit-lines for
further on-lending.
• The credit lines are often targeted at small and
medium enterprises or at specific sectors.
• To ensure the participation of other private
investors, A-loans are usually limited to 25% of
the total estimated project costs for greenfield
projects, or, on an exceptional basis, 35% in
small projects.
01/01/2010 685
IFC
• For expansion projects IFC may provide up to
50% of the project cost, provided its investments
do not exceed 25% of the total capitalization of
the project company.
• Generally, A-loans range from $1 million to $100
million.
• The Corporation is willing to extend loans that
are repaid only from the cash flow of the project,
without recourse or with only limited recourse to
the sponsors.)
• Syndicated Loans
• Equity Finance
01/01/2010 686
IFC
• Quasi-Equity Finance
• Equity & Debt Funds
• Structured Finance
• Risk Management Products
• Local Currency Financing
• Subnational Finance
(Joint IFC-World Bank Subnational Finance
Department : The Subnational Finance
Department is a combined initiative of the World
Bank and the International Finance Corporation.
01/01/2010 687
IFC
IFC provides states, provinces, municipalities,
and their enterprises with financing and access
to capital markets, without sovereign
guarantees.
On a selective basis it also provides financial
support to nationally owned enterprises
operating in natural monopoly infrastructure
sectors.
In all of its financings its primary objective is to
strengthen the borrowers ability to deliver key
infrastructure services such as water,
wastewater management, transportation, gas
and electricity, and to improve their efficiency
and accountability as service providers.)
01/01/2010 688
IFC
• Trade Finance
• Advisory Services:
• IFC offers a range of advisory services in
support of private sector development in
developing countries.
• IFC Project Cycle:
IFC offers a wide variety of financial products to
private sector projects in developing countries.
• The project cycle illustrates the stages a
business idea goes through as it becomes an
IFC-financed project.
01/01/2010 689
IFC
• Stages of the Project Cycle
• Application for IFC Financing
• A company or entrepreneur, foreign or domestic,
seeking to establish a new venture or expand an
existing enterprise can approach IFC directly.
• After the initial contacts and a preliminary review,
IFC may request for a detailed feasibility study or
business plan to determine whether or not to
appraise the project.
• Project Appraisal
• Typically, an appraisal team consists of an
investment officer with financial expertise and
knowledge of the country in which the project is
located, an engineer with the relevant technical
expertise, and an environmental specialist.
01/01/2010 690
IFC
• The team visits the site of the proposed project,
holds extensive discussions with the project
sponsors and evaluates the technical, financial,
economic and environmental aspects of the
project.
• After returning to headquarters, the team
submits its recommendations to senior
management of the relevant IFC department.
• If financing of the project is approved at the
department level, IFC's legal department, with
assistance from outside counsel as appropriate,
drafts appropriate documents.
01/01/2010 691
IFC
• Outstanding issues are negotiated with the
company and other involved parties such as
governments or financial institutions.
• Public Notification
• Before the proposed investment is submitted to
the IFC Board for review, the public is notified of
the main elements of the project.
• Environmental review documents are also made
available to the public.
• Board Review and Approval
• The project is submitted to IFC's Board of
Directors, which reviews the proposed
investment.
01/01/2010 692
IFC
• Resource Mobilization
• IFC seeks to mobilize additional finance by
encouraging other institutions to make
investments in the project.
• Legal Commitment
• If the investment is approved by the Board, and
if stipulations from earlier negotiations are
fulfilled, IFC and the company will sign the deal,
making a legal commitment.
• Disbursement of Funds
• Funds are disbursed under the terms of the legal
commitment signed by all parties.
01/01/2010 693
IFC
• Project Supervision
• Once funds have been disbursed, IFC monitors
its investments closely.
• It consults periodically with management, and it
sends field missions to visit the enterprise.
• It also requires quarterly progress reports
together with information on factors that might
materially affect the enterprise in which it has
invested, including annual financial statements
audited by independent public accountants.
01/01/2010 694
IFC, ADB
• Closing
• When an investment is repaid in full, or when
IFC exits an investment by selling its equity
stake, IFC closes its books on the project.
• Asian Development Bank (ADB):
• ADB extends loans and provides technical
assistance to its developing member countries
for a broad range of development projects and
programs.
• It also promotes and facilitates investment of
public and private capital for economic and
social development.
01/01/2010 695
ADB, OECF
• A project information document (PID) is
summary information on an ADB-assisted
project.
• Japanese Overseas Economic Cooperation
Fund (OECF) :
• Assistance Scheme/Program: The OECF
provides long-term, low interest loans and/or
takes equity in significant private sector projects
which are linked to the fulfillment of its
objectives.
• Loans to and investments in Japanese
corporations engaged in development projects in
developing countries can also be made.
01/01/2010 696
OECF
• Criteria : Any developing country can apply for
assistance under OECF‘s many programs. While
a Japanese partner is not mandatory, the
process takes place in Japan and support from a
Japanese partner is usually imperative.
• Priority will be given to the sectors of energy,
transportation, agriculture and education.
01/01/2010 697
FIs‟ guidelines for funding projects:
• The FIs‘ general approach to project financing:
The FI/Bank receiving an application from the
project sponsor scrutinises the proposal from
various angles as follows - to decide whether to
commit funds to the project or not, if yes, in what
form, up to what extent, timing of releasing the
funds, periodicity of recovery of interest and
principal etc.
• Whether the project is acceptable - by
examining the salient features such as the
background and experience of the applicant,
particularly in the line of activity;
01/01/2010 698
FIs‘ guidelines for funding projects:
• The potential demand for the project;
• The availability of the required inputs and utilities
and other infrastructural facilities;
• Whether the project is in keeping with the
priorities if any laid down by the Government;
• The Co‘s Memorandum and Articles of
Association to ensure that : there are no clauses
prejudicial to the lender‘s interest and no
limitations have been placed on the Co‘s
borrowing powers and operations.
• A credit report from the co‘s existing bankers to
ensure the creditworthiness of the borrower;
01/01/2010 699
FIs‘ guidelines for funding projects:
• The line of activities and financial position of the
associate/subsidiary concerns if any, and the
cos‘ financial involvement in them and the
overall structure of the inter-corporate
investments (the purpose of this is to study the
effect of diversion of resources of the co. to its
associates/subsidiaries);
• If any redeemable pref. shares or debentures
are issued, whether the redemption reserves
have been adequately built up;
01/01/2010 700
FIs‘ guidelines for funding projects:

• Particulars of the project along with the copy of
the project report furnishing the details of the
technology, manufacturing process, availability
of construction /production facilities; (Comments
about the technical/financial collaborators,
technical feasibility, cost of the project, suppliers
of the plant and machinery, etc.)
• Estimates of the cost of the project, detailing the
itemised assets acquired/to be acquired,
including the preliminary/preoperative expenses
and working capital margin requirements;
01/01/2010 701
FIs‘ guidelines for funding projects:
• Details of the proposed means of financing,
indicating the extent of promoters‘ contribution,
quantum of share capital to be raised through
public issue, the composition of debt – term
loans, deferred payment guarantees, foreign
currency loans if any, etc.;
• Working capital requirements at the peak level
during the first year of operations after
commencement of commercial production and
the banking arrangements to be made for
financing the WC requirements;
• Project implementation schedule together with
Bar Chart, PERT/CPM Chart;
01/01/2010 702
FIs‘ guidelines for funding projects:
• Organisational set up with the list of Board of
Directors, the qualifications, experience and
competence of the key personnel to be in
charge of the implementation of the project
during the construction period and the
executives to be in charge of the functional
areas of purchase, production, marketing and
finance after commencement of commercial
production;
• Demand projection based on the overall market
prospects together with a copy of the market
survey report;
01/01/2010 703
FIs‘ guidelines for funding projects:
• Estimates of sales, cost of production and
profitability;
• Projected Profit and Loss account and balance
sheet for the operating years during the currency
of the bank‘s term assistance;
• (Financial analysis : For an existing company,
comments about D/E ratio and the Current Ratio
– whether they are in acceptable range? ----D/E
ratio < 2 and CR >1.33
• Method of depreciation followed, changes made
and their implications on profit;
01/01/2010 704
FIs‘ guidelines for funding projects:
• Revaluations of fixed assets made in the past
and the quantum of revaluation reserves;
• Status of Co.s‘ Income tax and sales tax
assessments and provisions made for the
current year;
• History of past sickness or any defaults made in
the past;
• Nature and purpose and quantum of contingent
liabilities;
• Pending law suits by and against the co. and
their financial implications;
01/01/2010 705
FIs‘ guidelines for funding projects:
• Qualified remarks by the statutory auditors)
• Proposed repayment programme;
• Projected funds flow statement covering both the
construction period and the subsequent
operating years during the currency of the term
loan;
• Details of the nature and value of securities
offered; (Comments on the type of charges to be
created, in the case of sureties be they the co‘s
directors or third parties, their networth etc.)
01/01/2010 706
FIs‘ guidelines for funding projects:
• Consents from the Government and other
authorities and any other relevant information.
(Comments on the Industrial licence if any
obtained by the co., approval of
collaboration/technical know-how agreement,
clearance for import of plant and machinery, no
objections from the local authorities, clearance
from environmental pollution angle, etc.)
• (In the case of the existing concerns) particulars
regarding the history of the concern, its past
performance, present financial position etc. duly
supported by the statements such as P & L
account and B/S for the past years.
01/01/2010 707
FIs‘ guidelines for funding projects:
• The Application in the standard format of the
lending institution duly completed in all respects,
signed by the authorised signatories and
submitted will form the basis for the detailed
appraisal of the project by the lending institution.
• After a thorough examination of the various
aspects detailed above, the institution visits the
project site or the factory site (In the case of the
existing units).
01/01/2010 708
FIs‘ guidelines for funding projects:
• Each project is examined in proper perspective
having regard to its natures, size and scope.
For example, the approach for appraising the
proposal of an existing concern going in for
expansion or modernisation , an existing
concern setting up a new project, and new
concern venturing to set up a new project will all
be different.
• The ultimate objective of the lender‘s appraisal
exercise is to ascertain the viability of a project
with a view to ensuring the repayment of the
loan with interest.
01/01/2010 709
FIs‘ guidelines for funding projects:
• In the appraisal exercise, all the data/information
should be checked and wherever possible,
counterchecked through inter-firm inter-industry
comparisons.
• When the lender is confident of the success of
the project after a thorough appraisal, it issues a
‗Sanction Letter‘ to the co. along with the
detailed list of terms and conditions/covenants;
• creation of charges in favour of the lenders;
• disbursement of the loans in stages as agreed
between the lenders and the co. depending
upon the projected cash flows;
01/01/2010 710
FIs‘ guidelines for funding projects:
• and monitoring of the progress of the project and
recovery of the interest and principal.
• Depending on the size of the loan, more than
one bank/institution may participate in the
lending with a view to share the risk.
• In such a case, the co. appoints one bank as the
‗lead bank‘ , and prepares an ‗Information
Memorandum‘.
• The lead bank enlists the services of some other
banks in sharing the lending based on the
Information Memorandum.
• This process is known as ‗Syndication‘.
01/01/2010 711
FIs‘ guidelines for funding projects:
• For term loans, the lenders also charge a
―processing fee‘ of about 1% of the loan amount.
There may be an initial repayment holiday, till
the project starts commercial production and
then the repayments of the principal and interest
due would begin at monthly, quarterly or half
yearly intervals depending on the cash flows
projected.
• Since the lending institutions will charge penal
interest on the ‗overdue‘ amounts (i.e. the
amounts of principal and or interest not paid on
due dates), the project manager has to correctly
calculate the cash outflows on account of these
dues.
01/01/2010 712
FIs‘ guidelines for funding projects:
• Usually the loan documents stipulate certain
covenants such as: the board should have a
nominee from the lenders, additional funds
should be brought in by the promoters in case
of overrun; bar to undertake any new project
until the dues are paid in full; restrictions on
transfer of shares of promoters to others,
payment of dividends with the permission of
lenders etc.
• Working Capital Advances: Used for financing
the current assets.
• In the pre-production stage, finance is given in
the form of Cash Credit/Overdraft/Letter of
Credit.
01/01/2010 713
FIs‘ guidelines for funding projects:
• Under the Cash Credit/Overdraft system, the
bank fixes the maximum amount that the co. can
draw for its operations, called the ‗limit‘.
• Interest is charged periodically on the actual
amount utilised by the co.
• The operations are reviewed at the end of every
year and then renewed for another year.
• In the case of loans, the limit amount assessed
for working capital needs of the co. is given in
the form of a loan and interest is charged on the
entire loan amount till it is repaid.
01/01/2010 714
FIs‘ guidelines for funding projects:
• In some cases, the supplier of RM may demand
an LC in which case the bank gives the LC
facility also to the co. as part of the WC limits.
• LC is opened in favour of the supplier of the
RM, and on receipt of the stipulated documents
form the supplier, the bank pays the supplier.
The amount is then recovered by the bank from
the co.
• In the post production stage, the co. sells its
products, raises bills on its customers, some of
whom avail some credit periods for repayment.
01/01/2010 715
FIs‘ guidelines for funding projects:
• The bank discounts such bills on the co.‘s
debtors and credits the amount to the Cash
Credit/Overdraft account. Thus the cycle goes
on.
• Some of the typical covenants the FIS/banks
impose in their Sanction Letters:
• The bank/FI has the right to examine the books
of accounts and inspect the co‘s factories at the
co‘s cost.
01/01/2010 716
FIs‘ guidelines for funding projects:
• During the currency of the loan:
× the co. should not alter the capital structure,
× should not formulate any scheme of
amalgamation/merger,
×should not undertake any new project, or
expansion scheme,
×should not invest or lend to others other than
normal trade credits,
×should not enter into any borrowing
arrangements with any other lender,
01/01/2010 717
FIs‘ guidelines for funding projects:
×should not declare dividends except out of profits,
×should not create any charge on the assets of the
co. in favour of any other FI/bank or persons,
× should not undertake any trading activity other
than the sale of its products,
×should not permit any transfer of the controlling
interest or make any drastic change in the
management set-up.
×should not repay the loans to its promoters/
directors/ friends /relatives without the written
permission of the bank,
×the bank will have the option of nominating a
director on the board of the co. etc.
01/01/2010 718
Risk Analysis
• Risk is inherent in capital budgeting decisions,
as the benefits and costs will extend over a long
period.
• For simplicity, so far it has been assumed that
the firm would face the same risk in the new
projects, as it has been facing earlier in its
existing business.
• Hence the average cost of capital was used for
evaluating the new projects.
• But in reality the risk in every project may be
different – for example, the risk in a research
project may be much more (due to uncertainty of
the outcome) than an expansion project.
01/01/2010 719
Risk Analysis
• Therefore the risk in each project has to be
identified and measured separately so as to
arrive at the correct conclusions.
• If in a given situation, all the future events are
known beforehand, it is described as certainty.
• Uncertainty the opposite condition is the
situation in which the future events are not
known.
• Risk is a situation, where the possible events are
known, but which of those will actually happen is
not known.
• However, the probability of their occurrence can
be determined.
01/01/2010 720
Risk Analysis
• Risk analysis is a complex area in Project.
• There are different techniques that are applicable
for the ‗stand-alone‘ risk of a project and the risk
that the project in the context of the firm.
• Sources, measures and perspectives on risk:
• Risks can be broadly classified into two categories
: Business risk and financial risk. All kinds of risk
can be included in one of the these two risks.
• Risks may be project-specific, competitive risk,
industry-specific risk, market risk and international
risk.
01/01/2010 721
Risk Analysis
• Project specific risk: the earnings and cash flows
of the project may be lower than expected
because of estimation errors or due to some
other factors.
• Competitive risk: Risk arises due to the
unanticipated actions of the competitors.
• Industry –specific risk: arises due to changes in
technology, regulations that are specific to the
industry to which the project belongs. These
risks will affect the cash flow and hence the
earnings of the project.
01/01/2010 722
Risk Analysis
• Market risk: arises due to changes in
macroeconomic factors like fall in the GDP
growth rate, interest rate, inflation rate, affecting
the cash flows and earnings of the project.
• International risk: arises in the case of a foreign
project due to changes in exchange rates or
political conditions/decisions in the foreign
country.
• The more important measures of risk are range,
standard deviation, coefficient of variation and
semi-variance.
01/01/2010 723
Risk Analysis
• The weighted NPV works out to 540.
• The Range is 700
• Standard Deviation  =  { p
i
(x
i
– x
a
)
2
}
½
where
 = Standard Deviation, p
i
= probability of the ith value,
x
i
= ith value , x
a
= expected value.
• The  of the NPV distribution = 249.8;
• Variance = 2 = 62,400.
NPV Probability
200 0.3
600 0.5
900 0.2

•Let us take an example to explain the measures.

01/01/2010 724
Risk Analysis
• Coefficient of variation (CV): Standard Deviation
(SD) is expressed in absolute values and so by
comparing the SDs you cannot conclude which
of them is better.
• For example, if you compare two projects with
expected NPVs Rs. 10 million and Rs. 1 million
with SDs of Rs. 1 lakh and Rs. 90000/- ,
comparison of SDs, will give a decision that the
second project should be selected.
• The CV adjusts the SD for scale and is defined
as: CV = SD/Expected value.
• So CV in the example = 249.8/540 = 0.46.
01/01/2010 725
Risk Analysis
• Semi Variance (SV) : SD considers all
variances – both positive and negative. Since
investors are concerned only about negative
deviations, SV seems to be a more suitable
measure of risk.
• SV =  p
i
d
i

2
, where d
i
‟ = d
i
when d
i
< 0 .
• So in our illustrative example, SV = 34680.
• By extension, the Semi SD = the square root of
the SV = 186.2 in the example.
01/01/2010 726
Risk Analysis
• SD and Variance are the most commonly used
to measure risk, since:
• (a) SD has the same units as the original
variable, and can be interpreted easily.
• (b) SD is the measure of dispersion which
characterises the normal distribution. If a
variable is normally distributed, its mean and SD
contain all the information about its probability
distribution,
• (c) it is easily tractable.
01/01/2010 727
Risk Analysis
• Use of subjective probabilities: Probability
distribution is required to measure the expected
value and dispersion.
• It may be possible to define the probability
distribution with a high degree of objectivity, on
the basis of past evidence.
• These are called ‗objective‘ probability
distribution.
• But in real life, such objective evidence may not
be available for defining probability distributions.
01/01/2010 728
Risk Analysis
• In such cases, the experience and judgment of
some knowledgeable persons is pooled to
define the Prob. Distribution.
• These are ‗subjective‘ probability distributions.
• Perspectives on risk: Irrespective of the
measure of risk used, there can be at least three
perspectives and they are:
• Stand-alone risk: Represent the risk of a project,
when it is viewed in isolation;
• Firm risk: (Also known as Corporate Risk‘). This
reflects the contribution of the project to the risk
of a firm.
01/01/2010 729
Risk Analysis
• Systematic risk: (also called the market risk), this
represents the risk of a project from the point of
view of a diversified investor.
• Methods of Risk Adjusted Investment appraisal:
Let us see how to incorporate the risk factor into
the investment appraisal.
• Certainty Equivalent method: This method is
based on the utility of the decision maker.
• For example consider the scenarios of cash flows
in a project and their probabilities in the second
year : Rs. 20000 – 75% and Rs. 30000 – 25% .
• So the expected inflow in the second year is
Rs. 22500.
01/01/2010 730
Risk Analysis
• The Project Manager would rather prefer a certain
outcome of Rs. 10000 rather than Rs. 22500 which
is subject to some probabilities.
• Here the Certainty Equivalent Co-efficient of the
cash flows is worked out as: 10000/22500
= 0.44.
• This method is useful when the risk-return
perceptions of the project manager differ from year
to year.
• First the certainty equivalents are calculated and
then the certainty equivalents of cash flows are
calculated.
• The cash flows are then discounted with the risk
free rate of discount, as the risk adjustment has
already been made.
01/01/2010 731
Risk Analysis
• 0 ≤ CEC ≤ 1. The higher the CEC, higher is the
confidence of the management on the
forecasted cash flows. As a general rule, the
CEC reduces for the later years as risk
increases.
• We can see an example to see how the CEC is
applied.
• A co. has cost of capital 10%, and the risk free
rate of discount is 8%, the project cash outlay is
Rs. 10 lakhs, and inflows in the first and second
years would be Rs. 20 lakhs and Rs. 25 lakhs.
The project would have a life of two years and
salvage would be negligible………..
01/01/2010 732
Risk Analysis
………The promoters‘ estimates of the CEC for the
two years would be 0.85 and 0.75. Find the risk
adjusted NPV of the project.
• NPV = Rs. (20000 *0.85)/1.08 + (25000 *
0.75)/1.08
2
- 10 = Rs.31.79 lakhs.
• Risk adjusted Discount Rate Method: Since
different projects have different risk levels, the
discount rates also have to be different to reflect
the risks.
• In the simple NPV method, it was assumed that
the risk characteristics of the new projects are
the same as the investments already made by
the firm.
01/01/2010 733
Risk Analysis
• But in this approach, the new projects are
discounted at the rate which incorporates the
risk element of the new project.
• So the Risk Adjusted Discount (RAD) rate i‘
consists of three components :
the risk free rate of discount r, the premium for
the normal risk of the firm u and the premium for
the extra or below normal risk of the new project,
a. i.e i‘ = r + u + a.


01/01/2010 734
Consider the following example for
understanding how the RAD is applied.

Cash flow in years 1 to 5 Cash flows in years 6 to 10 Initial Outflow
Probability Amount Probability Amount
0.20 2.0 0.20 2.60
0.40 2.40 0.60 3.20
0.30 2.80 0.10 3.40

14
0.10 3.40 0.10 3.60

01/01/2010 735
Risk Analysis
• The co‘s cost of capital is 13% and the extra
premium required for the new project is 2%.
• Ans: Expected cash flows in each of the first
five years = Rs. 2.54;
Expected cash flows in the years 6 to 10 (each) =
Rs. 3.14 ;
• NPV = - 14 + 2.54 x PVIFA (15,5) + 3.14 x
PVIFA (15,5) x PVIF (15,5)
= 0.255
• In this example, the discount rate of 15% has been
used for al the 10 years. However, keeping in
view the change in the risk factors, different
discount rates may be used for different years.
01/01/2010 736
Risk Analysis
• Calculation of Standard Deviation of NPV-:
• Perfectly correlated cash flows are obtained
when there are no factors that cause uncertainty
such as competition, non-availability of raw
materials, fluctuation in demand etc.
• The behaviour of the cash flows in all periods is
the same and they are linearly related to each
other.
• In such cases,
n
the expected NPV =  {A
t
/(1+i)
t
} – I ,
i =1
01/01/2010 737
Risk Analysis
n
and SD of the NPV =  
t
/(1+i)
t
i =1
i= 1
• where A
t
= expected cash flows,
i = the risk free discount rate,
t = life of the project and

t
= SD of the cash flows.
01/01/2010 738
Risk Analysis
• (See an example in ICFAI‘s Finance Series Vol
II –chapter 4: Pages 117 – 118: Data is given
about the mean cash flows for the number of
years, the respective SDs, and the risk free
interest rate is given. And so the working is
quite simple.)
• Uncorrelated cash flows: When the firm
operates in conditions of uncertainty, the cash
flows cannot be correlated, i.e. In conditions of
severe competition, heavy ad. expenditure etc.
which make the cash flows of each year
independent of the others.
01/01/2010 739
•Here the formula for the NPV is the same but the
formula for the SD changes to :

n
 (NPV) = {  
t

2
/(1+i)
2t
}
1/2
i = 1
01/01/2010 740

Quantitative aspects of projects -
PERT/CPM, Network analysis for
monitoring of the project

• It is well known that management of any project
involves the activities of planning, coordinating,
monitoring, control and review of the
performance of a number of inter-related tasks
with limited resources.
• The Project Manager has also to be aware of the
consequences of deviations from the initial plan
– like time overruns and cost overruns.
• Therefore they look for dependable devices to
achieve proper control.
01/01/2010 741
Network Techniques
• Network techniques are primarily used in
project management, particularly in dealing with
non-repetitive operations.
• Network techniques provide the help a manager
needs, when he is defining the complex
relationship that exists in sequencing and time
between many jobs and planned elements of
work.
• During the actual execution of the project the
slippages occur.

01/01/2010 742
Network Techniques
• Network is an arrow diagram, which is a
graphic representation of the project plan.
• It depicts the logical sequence of the various
elements for work, in relation to each other, that
must be accomplished before a project can be
completed.
• A network consists of ‗events‘ and ‗activities‘.
• Therefore it is necessary to divide the project
into clearly defined major components and to
recognise the ‗events‘ that mark the start and
completion of each ‗activity‘. ( You may
recall this is nothing but the WBS).
01/01/2010 743
Network Techniques
• An ‗event‘ is an occurrence at a point in time
marking the commencement or completion of
one or more activities.
• The symbol for an event is a circle.
• Major events are marked by squares or
rectangles.
• Events are numbered logically, starting from the
‗head‘ events to the ‗tail‘ events and are
inscribed inside the circle.
• An event is said to occur when all the activities
leading to it are completed.
01/01/2010 744
Network Techniques
• To put in different words, an event is : (a)
the start or completion of a task; (b) a
significant point or milestone in a project and (c)
consumes in itself no time or resources.
• An ‗activity‘ represents a clearly defined project
element, work, job or task, which forms an
integral part of a project and needs time and
resources for carrying out.
• There are examples of activities when no work is
done but they occur in between two
‗events‘…………
01/01/2010 745
Network Techniques
…..– for example curing time for concrete and
involves only the passage of time, or waiting for
a letter of sanction for loan from a bank .
• The symbol for an activity is an arrow – the tail is
the start of one activity from the previous ‗event‘
and the head is the end of the activity,
culminating at the next ‗event‘. The length of an
arrow does not represent the time taken by the
activity.

01/01/2010 746
Network Techniques
• The basic rules for drawing a network are
summarised below:
• Have a clear objective for which the network is
required;
• Split the objective into broad areas of work
(WBS);
• List the activities in a logical manner;
• Plot all the activities in the sequence as decided;
• Examine which activity has taken place, which is
currently going on and which is the next;
01/01/2010 747
Network Techniques
• It has a single start event and a single final
event; there cannot be any loops or danglers;
all the paths of the network arse continuous and
proceed from left to right;
• The network plan should have a time-table of
work, with each job allocated a start and finish
date to ensure that the resources required to
execute the job will be available when needed.
• The time each job will take to be completed has
to be estimated and noted against the job in the
network diagram.
01/01/2010 748
Network Techniques
• Master networks: In large projects, it is
desirable to prepare a number of separate
networks-for each specific level of management
which reflects the degree of detail and interest to
that particular level or separate networks for
each individual portions of the project.
• The network for the entire project is called the
Master Network.
• The end events of each separate network are
integrated and shown in the master network.
01/01/2010 749
Network Techniques
• A network is not completed until the project is
completed.
• Advantages of network planning:
• It enables the break-up of the total project into
sets of individual jobs or events and arranges
them in a logical sequence;
• It estimates the duration and resource
requirements of the individual job and hence
facilitates the allocation of resources;
• It identifies the trouble spot in advance and
pinpoints responsibilities;
01/01/2010 750
Network Techniques
• Since the executives of all the departments
participate in drawing the network, their
commitment is ensured to stick to the schedules;
• In case of any change in the management team,
the subsequent team can easily carry on with
the project with the help of the network analysis;

01/01/2010 751
Network Techniques
• It indicates the optimum start and finish times for
each activity in an operation, and allows the
operations that follow a set pattern to be partly
pre-planned, speeding up the final planning;
• It is an important means of training the
personnel in the techniques of handling the
operations;
• It allows for multi-project scheduling by
computer.
01/01/2010 752
PERT
• PERT: A new family of planning and techniques
has helped the development of the defence,
construction, chemical and other industries.
• Some of them are: PERT, PERT/Cost,
PERT/Time, CPM, CPA (Critical Path Analysis),
CPS (Critical Path Scheduling) GERT (
Graphical Evaluation and Review Technique)
and PERT is the best known among these
techniques.
• PERT was first introduced by the US Navy for its
Polaris weapon system in 1958.
01/01/2010 753
PERT
• In India, large PSUs as well as Pvt. sector giants
use PERT for their projects.
• The requisites of PERT are:
• The project goal needs to be clearly identified,
visualised in a logical manner and are put in a
network flow diagram, comprising events and
activities;
• All activity paths need to be completed by
appropriate events and a description of each
activity needs to be written above the arrow
linking the events;
01/01/2010 754
PERT
• Events and activities need to be sequenced so
as to allow the determination of the critical paths,
and all constraints and inter-dependencies
should be shown in the diagram;
• The PERT network analysis consists of the
following steps:
• Clearly defining the goal of the project;
01/01/2010 755
PERT
• Preparing the WBS to a set of individual jobs
and arranging them in a logical fashion;
• Estimating the job duration, making provisions
for optimistic and pessimistic schedules;
• Identifying the resource requirement constraints;
• Locating the schedule of dates for each activity
by planning a detailed control structure;
01/01/2010 756
PERT
• Preparing project control systems, and
identifying the requirements of progress reports
for different levels of management;
• Developing the critical path and slack times;
• Crashing the time –optimum cost levels on the
basis of costs;
• Updating the network continuously by
systematised methods;
• Monitoring, evaluating and reviewing the
network constantly.
01/01/2010 757
PERT
• Benefits of PERT:
• PERT gives management the ability to plan the
best possible use of resources to achieve a
given goal within the overall time and cost
limitations;
• It helps the project manager to handle the
uncertainties involved in programming where
no standard time data are available;
• It utilises the time network analysis as a base
method of approach to determine manpower,
material, machinery and capital requirements.
01/01/2010 758
PERT
• It is an effective mechanism for planning,
scheduling and co-ordinating the different
activities in project buying. (Nowadays a PERT
networks charts are a ‗must‘ for every tender
submissions to public sector projects);
• It is useful for annual shutdown and overhauls to
identify the critical activities;
• It not only helps the management in deciding
when to initiate the follow – up and provide
materials, but also gives an estimate of the
consequences of not meeting such demands;
01/01/2010 759
PERT
• It enables the optimum utilisation of the
resources by their transfer from the slack to busy
segments in the network in order to accomplish
the stipulated goal.
• PERT is one of the most important techniques of
scientific management in project planning with
the minimum possible scheduling time and use
of resources.
• Inefficiencies in personnel loading can be
removed by the proper use of slack activities,
lead time can be analysed and hence work
schedules can be expedited.
01/01/2010 760
PERT
• PERT network reveals the interdependencies
and problem areas which are either not
obvious, or not well defined by the conventional
methods;
• PERT allows a large amount of data to be
presented in a systematic orderly manner and
keeps the management posted up to date by the
principles of exception;
• PERT has been effectively used in many areas
since it offers a trade-off relationship between
time, cost and performance objectives on a
scientific basis.
01/01/2010 761
PERT
• The kind of probabilistic approach adopted in
PERT is useful in bidding for contracts by
working out the expected performance based on
experience.
• If individual activities are delayed, then the
extension of time permitted can be computed.
• These computations help in the calculation of
the tolerances for activity times in execution for
selective management control.
01/01/2010 762
PERT
• Project duration and variation:
• Project network is concerned with the control of
time.
• Hence the activity time or duration associated
with each activity has to be estimated by
experience, work measurement and intelligent
guess.
• Three time estimates are made – the optimistic
t
o
(hope that everything will go well without any
hitch – the minimum time – a very low chance of
realisation in reality),…………
01/01/2010 763
PERT
• …….. the pessimistic t
p
(the assumption
that everything will go wrong – the
maximum time – a very low chance to
occur in reality) , the most likely t
m
(not the
average of t
o
and t
p
but estimated from
experience and intelligent guess) for each
activity for the persons responsible for
implementing the activity.
01/01/2010 764
PERT
• From these three time estimates, the expected
time t
e
is calculated by using the empirical
formula: t
e
= (t
o
+ 4 t
m
+ t
p
)/6
• Slack and critical activities: The expected
‗elapsed time‘ required to perform an activity in
the network is based on the normal working
conditions.
• After calculating the ‗expected time‘ te for each
activity, they are cumulated from the start till
the end through the various paths.
01/01/2010 765
PERT
• The earliest project completion time T(E) is
identified for each event as well as the final
event in the PERT network.
• In computing the latest allowable time T(L),you
have to work backward from the completion time
for each event , and is obtained by subtracting
the expected elapsed time estimate from the
final goal and moving backwards through the
various paths The chart is analysed by adding
the estimated times. along each of the many
paths, from beginning to the end of the job.
01/01/2010 766
PERT
• In forward pass, for converging activities in
junctions, we take the largest value of T(E) ;
while in the backward pass in the reverse
direction, for converging values, we take the
smallest value T(L).
• Thus for every event, there are two values T(E)
and T(L).
• Wherever these two values coincide, the
commencement of that activity cannot be
postponed, without introducing delay in the
completion of the project.
01/01/2010 767
PERT
• This is known as ‗slack‘. This positive difference
gives the margin of time by which the
commencement of an activity can be
deliberately delayed without dislocating the
duration of the project.
• The slack of an event is defined as the
difference between the latest and the earliest
available time to do a job and is also called
the „float‟.
• The activities that fall on the events of zero slack
trace the critical path.
01/01/2010 768
PERT
• IN SHORT,THE ALGORITHM FOR LOCATING
CRITICAL ACTIVITIES IS TO OBTAIN T(E)
AND T(L), AND THE ACTIVITIES WITH ZERO
SLACK TIME.
• The events with zero slack are identified as
critical events, and the path that passes through
the critical events is the critical path.
• Critical path interpretation: Slack is associated
with non-critical activities. In a network, the
path having the least slack is the critical path. It
is also the longest path which consumes
maximum time.
01/01/2010 769
PERT
• As the name suggests, each activity in the
‗critical path‘ is critical, since a delay in any of
the events in this path will cause the entire
project to fall behind schedule, unless additional
resources and personnel are made available.
• By concentrating on the critical path, the Project
Manager can transfer facilities from the slack
path to the critical path, in order to minimise
delays.
• Zero slack indicates that the project will be
completed on schedule.
01/01/2010 770
PERT - CPM
• A positive slack indicates that the project will be
completed ahead of schedule and a negative
slack indicates that the event is likely to slip
behind the scheduled date.
• See an example in Chapter 5, Pages 36 to 38 of
the book PG.
• Critical Path Method: It is a mathematically
ordered system of planning and scheduling for
project management, which makes possible a
balanced, optimum time cost schedule and
assures timeliness and minimum use of
resources.
01/01/2010 771
CPM
• The method was first used by Du Pont to
improve the planning , scheduling and
coordinating of its new Plant construction.
• Like the PERT, this method is also based on the
network principle.
• An event represents a specified programme
accomplishment at a point in time, while an
activity represents the time and resources
required to progress from one event to another.
01/01/2010 772
CPM
• After the network diagram is established, the
time and cost estimates are applied to each
activity.
• With the normal estimate, the prime
consideration is minimum cost with the
associated time.
• As attempts will be made to reduce it later,
normal time is considered as the maximum
time.
• But the costs associated with normal times are
assumed to the minimum costs.
01/01/2010 773
CPM
• The ‗crash‘ estimate is defined as the absolute
minimum time and the associated cost in relation
the maximum cost.
• It is assumed that linear cost relation exists
between normal and crash estimates for each
activity.
• PERT uses three time estimates to arrive at the
‗expected time‘ of each activity.
• The CPM user is assumed to be on less
uncertain ground and to have had some prior
experience with the activities comprising the
project.
01/01/2010 774
CPM
• The estimates of normal and crash times are
assumed to be quite specific and made with a
fair degree of confidence.
• Similarly the cost estimates are also assumed to
be based on a fair degree of definiteness and
confidence based on prior experience.
01/01/2010 775
-.
-The following differences may be observed between CPM and PERT:
CPM PERT
Networks are ‗Activity‘ oriented –
emphasises the description associated with
the activities in a network.
Networks are ‗Event‘ oriented
-
A deterministic model – cost conscious A model under Risk –
concerned with time;
Particularly useful where the decision
variables can be predicted with reasonable
accuracies as in construction projects. If the
most likely time is known, then it may be
used a deterministic value
The time for one or more
activities follow a probability
distribution; takes into account
the uncertainties.

01/01/2010 776
CPM
• Assumptions of PERT and CPM:
• Both assume that the project is definable by
activities that have distinct beginning and ending
points.
• Construction of CPM: The basic steps involved
are:
• Break the entire project into smaller systems,
known as tasks;
• For each task, determine the activities and
events to be performed;
01/01/2010 777
CPM
• For each activity, determine the preceding and
succeeding activities;
• For each activity, determine the time and other
resources needed;
• Draw a network plan depicting the assembly as
discussed in the previous chapter, considering
only the expected time estimate. Events are
represented by circles called ‗ nodes‘.

01/01/2010 778
CPM
• Ground rules for construction of the CPM are:
An event cannot occur until all the activities
leading to it are completed and an activity
cannot start until its preceding event has
occurred;
• An event can occur only once;
• The time flow is from left to right;
• The earliest occurrence time of the initial event
is set to zero, and we proceed through the
diagram ;
01/01/2010 779
CPM
• The earliest occurrence time can be calculated
only if the preceding events‘ earliest occurrence
times are calculated; the earliest and latest
occurrence times are plotted in the chart.
• The arrow diagram is common to both PERT
and CPM; THE DIFFERENCE LIES IN THE
DATA ENTERED ON THE DIAGRAM.
• An activity can start only when all the preceding
activities have been completed.
• Therefore, the earliest occurrence time of an
activity is precisely the earliest occurrence of the
predecessor event.
01/01/2010 780
CPM
• The start time of an activity plus its activity
duration gives its finish time.
• Thus, the earliest finish times of activities are
the earliest start times of the activities plus their
duration.
• The latest finish time of an activity is precisely
the latest occurrence time of its successor
event, a later finish would delay the project
• The finish time of an activity minus its activity
duration gives its start time.
• Thus the latest start times of activities are the
finish times of activities which require the
greatest normal time.
01/01/2010 781
CPM
• The critical path is that sequence of activities
which require the greatest normal time to
accomplish.
• Based on the normal times for each activity,
earliest start dates are computed for all activities
along any path by working forward from the
beginning of the path activity in the path.
• Similarly, the latest finish date and earliest finish
date for all activities in a given path are
computed.
01/01/2010 782
CPM
• It may be mentioned that sufficient leeway is
possible for any path other than critical.
• Events with zero slack are known as critical
events and the path that traverses through
critical events is the critical path.
• Non critical activities can be increased in
duration, since there is time to spare to complete
these activities but without exceeding the critical
path time.
01/01/2010 783
CPM
• Float calculation: ‗Free Float‘ is the maximum
time slippage of an activity that can be tolerated
without affecting the completion date of any
other activity in the situation where both the
preceding and succeeding activities are
assumed to start at the earliest possible times.
• THE FLOAT OF THE ACTIVITIES IS THE
DIFFERENCE BETWEEN EITHER THE
LATEST START AND EARLIEST START OR
BETWEEN THE LATEST FINISH AND THE
EARLIEST FINISH.
01/01/2010 784
CPM
• The ‗Total Float‘ is the maximum slippage of an
activity or the spare time that can be tolerated
without affecting the completion date of the
overall project.
• Here the assumption is that all the preceding
activities start as early as possible and all
succeeding activities start as late as possible.
• THE DIFFERENCE BETWEEN THE START
AND COMPLETE EVENTS OF THE
ACTIVITIES IS THE TOTAL FLOAT.
01/01/2010 785
CPM
• ‗Independent Float‘ is the maximum slippage of
an activity that can be tolerated without affecting
the latest completion date of any other activity
under the situation where all preceding activities
are completed as late as possible and all
succeeding activities are started as early as
possible.
• The duration of an activity with independent
float can be increased by the amount of float
without affecting the progress of the succeeding
activities, or the float available to preceding
activities.
01/01/2010 786
CPM
• IT IS CALCULATED BY DEDUCTING THE
LATEST EVENT TIME OF START EVENT AND
DURATION OF ACTIVITY FROM THE
EARLIEST EVENT TIME AND END EVENT
FOR ANY ACTIVITY.
• Free Float is the duration by which the float of an
activity can be increased without affecting the
progress of succeeding activities.
• This will reduce the amount of total float
available for preceding activities. Free float
occurs only in the last of a series of activities
leading to a critical path.
01/01/2010 787
CPM
• Critical Path and Management Decisions:
• The activities for which positive slack time is
available can be performed at a slower pace,
thereby releasing some of the resources for use
in the critical activities, provided the activities are
interchangeable.
• Total duration of the project can be reduced
only by reducing the duration of the activities on
the critical path.
01/01/2010 788
CPM
• When a project network is executed and one or
more time estimates, change, the entire network
may have to be reconstructed and the new path
of critical activities identified.
• Slack is the difference between the latest event
time and the earliest event time for a particular
event.
• Total Float ={T(L) of succeeding event minus
T(E) of the preceding event} – t(e);
• Free Float ={T(E) of succeeding event minus
T(E) of the preceding event} – t(e);
01/01/2010 789
CPM
• Independent Float = {T(E) of succeeding event
minus T(L) of preceding event}- t(e) ; (If
negative, the Independent Float is taken as
zero.),
• Where t(e) is the ‗Expected Activity Time‘, T(E)
is the ‗Earliest Event Time (the earliest time an
event can occur), T(L) is the ‗Latest Event Time (
(latest possible time at which an activity can start
)
• ―Interference Float‘ is the difference between
total float and free float.
01/01/2010 790
CPM
• ‗Resource Levelling‘ is the scheduling of activity
start times such that resource levels are kept at
the minimum possible;
• ―Resource Smoothing‘ is the scheduling of
activity start times within the limits of their total
floats, such that the targeted project duration is
maintained and fluctuation in resource
requirements are minimised;
01/01/2010 791
CPM
• ‗Crashing‘ is the process of advancing the
completion date of the project to suit a revised
and reduced project duration by reducing the
duration of one or more activities on critical path.
• This is also known as ‗activity compression‘;
• ‗Activity Crash Time‘ is the revised and reduced
activity time;
• ‗Crash Cost‘ is the increase cost of crashing a
project;
01/01/2010 792
CPM
• ‗Cost Slope‘ is the additional cost to be incurred
in reducing an activity time per unit time.
• Compression on Critical Path:
• Need for crashing: The duration for the project
completion as planned by the project manager
may be more than that stipulated by the
management. In that case, it would be
necessary to have a re-look at the network.
01/01/2010 793
CPM
• The time-cost trade-off or crashing the network
is directed to the cost of determining a schedule
of project activities which considers adequately
the indirect as well as the direct costs.
• The total time can be reduced by ‗crashing‘,
‗compressing‘ or ‗completing‘ the critical
activities in less time.
• Obviously this will involve a higher cost than
would be incurred when performing at the
original rate.
01/01/2010 794
CPM
• Compression is achieved by:
• Closer examination of the time estimates of the
critical activities;
• Introducing greater paralleling i.e. more
concurrent activities and or changing or lowering
performance requirements of certain activities;
• Dropping off low priority activities, as a last
resort,
01/01/2010 795
CPM
• Transfer or reallocation of slack resources if
possible, from non critical activities to activities
on the critical oath;
• Addition of more resources to the critical path,
and crashing other activities.
• It should be noted that time and cost are
inversely correlated.
• Due to technological constraints, any activity will
have a minimum time requirement, below which
it cannot be reduced further.
01/01/2010 796
CPM
• For example, duration of construction activity
cannot be reduced below a certain limit due to
constraints like time taken for curing of concrete
etc.
• The activity will have a normal time requirement.
In between these two limits, the time required
can be reduced by deploying additional
resources/money.
• This procedure is known as ‗crashing‘ and the
extra cost incurred is the ‗crashing cost‘.
01/01/2010 797
CPM
• The usual practice is to crash the initial
activities on the critical path.
• The activity with the lowest slope is chosen
for crashing.
• After a few such steps of crashing, more than
one path may be come critical.
• This implies that a new schedule with
increased cost but with less time is obtained.
• The additional cost and benefit have to be
reviewed at each stage of crashing-direct,
indirect and opportunity cost are included in
the total cost.
01/01/2010 798
CPM
• The opportunity cost is the penalty for
not accomplishing the job in time.
• The extra cost per unit of time =
(Crash Cost- Normal Cost)/(Crash
time – Normal time). = cost slope.
01/01/2010 799
CPM
• Looking though the critical path and the cost
slope, the activity with the smallest slope has to
be crashed.
• The time – cost relationship helps the manager to
determine when diminishing returns make further
time saving uneconomical.
• As long as the extra cost incurred in crashing is
commensurate with benefits, it is worthwhile
crashing the activities, and thereby reducing not
only the time of the project without incurring a
total extra cost, but also quite often the total cost
itself.
01/01/2010 800
-
Let us see an example:
Time Estimate Activity Numerical
Description
Optimistic t
o
Most Likely
t
m

Pessimistic
t
p

Average
t
e
= (t
o
+ 4t
m

+ t
p
)/6
a 1 – 2 9 12 21 13
b 1 – 3 6 12 18 12
c 2 – 4 1 1.5 5 2
d 3 – 4 4 8.5 10 8
e 2 – 5 10 14 24 15
f 3 - 5 1 2 3 2

01/01/2010 801
The net work diagram would be as follows:









3
1
2
4
5
13
12
8
2
15
2
01/01/2010 802
Earliest Occurrence Time for Each event (EOT), Latest Occurrence of Each
Event (LOT) and Slack :


Event

EOT of
event
(Forward
Pass)

LOT of
event
(Backward
Pass)
Slack
=
LOT-
EOT
5 28 28 0
4 20 26 6
3 12 18 6
2 13 13 0
1 0 0 0

01/01/2010 803
CPM
• The paths 2 – 4 and 1 – 3 are slack paths each
having a slack of 6 and so cushion.
• The path 1 – 2 -5 which does not have any slack
is the critical path.
• The minimum required time to complete the
project is the duration of the critical path which is
28.
01/01/2010 804
The net work diagram would be as follows when the EOT/LOT are incorporated
in it. in the box showing the event no;:











1 –0/0
2 – 13/13
5 – 28/28
13
12
2
15
2
3 – 12/18
8
4 – 20/26
01/01/2010 805
CPM
• Activity Floats: Once you know the activity
times and the event slacks, activity floats can be
calculated.
• In the above example, for the activity 2 – 4, the
Total float :
= LOT (4) – EOT(2) – te (2-4) =
26 – 13 -2 = 11;
• The Free float :
= EOT (4) – EOT ( 2) - te (2-4) =
20 – 13 – 2 = 5;
01/01/2010 806
CPM
• And the Independent float:= EOT (4) – LOT (2) -
te (2-4) = 20 -13 – 2 = 11.
• Similarly the total, free and independent floats
for the activity 3 -4 are: 6, 0 and -6.
• Similarly the floats for the other activities can
also be found out.
• You will observe that all the floats are zeroes for
the activities along the critical path. (Activities 1
– 2 and 2 – 5 in the above example.)
01/01/2010 807
CPM
• The independent float represents the float under
the most adverse conditions.
• Hence when an activity has a positive
independent float, it means that the activity has
a cushion irrespective of what happens
elsewhere.
• However, the independent float of an activity
may be negative but the total float and free float
cannot be negative.
01/01/2010 808
CPM
• Measures of variability:
• Variability in PERT analysis is measured by
variance or SD.
• The steps involved calculating the SD of the
duration of critical path are as follows:
• Determine the SD of the duration of each activity
on the critical path;
• Determine the SD of the total duration of the
critical path on the basis of info obtained in the
previous step;
01/01/2010 809
CPM
• For determining the SD of the duration of an
activity, we require the entire probability
distribution of the activity distribution. But we
have only three values from this distribution viz.
t
o
, t
m
and t
p
. In PERT analysis a simplified
formula for Standard Deviation is used which is :
 = (t
p
- t
o
)/6.

01/01/2010 810
-For the example , the  and variance of the activities along the critical path are
as follows:
Activity t
p
t
o

 = (t
p
- t
o
)/6.

Variance = 
2

1 – 2 21 9 2 4
2 – 5 24 10 2.33 5.43

Variance of the critical path duration
= Sum of variances of activity durations on the critical path = 9.43;
SD of the critical path duration = √9.43 = 3.07.
Thus we have found that the mean and SD of the duration of the activities on the
critical path are 28 days and 3.07 days.
01/01/2010 811
CPM
• For real life projects, which have a large number
of activities on the critical path, we can
reasonably assume that the critical path duration
is approximately normally distributed, with the
mean and SD obtained as shown earlier.
• A normal distribution looks like a bell shaped
curve, is symmetric, is single peaked and is fully
described by its mean and SD.
01/01/2010 812
CPM
• The probability of values lying within certain
ranges is as follows:
• Range: Mean ± One SD : Probability
: 0.682;
Mean ± Two SDs: :0.954;
and
Mean ± Three SDs :
0.998.

01/01/2010 813
CPM
• Probability of completion of a project by a
specific date:
• If we have the mean (T), and SD  for critical
path duration, which is normally distributed, we
can compute the probability of completion by a
specified date (D) as follows:
– Find Z = (D – T) / , where Z represents the
no. of SDs by which D, the specified date
exceeds T.
– Obtain cumulative probability up to Z by
looking at the probability distribution of the
standard normal variate.
01/01/2010 814
CPM
– (Determining Z is equivalent to converting our
specific normal distribution into standard
normal distribution.
– The mean and SD of standard normal
distribution are 0 and 1 respectively.)

01/01/2010 815
Now let us calculate the probability of completion of the project in 20, 25 and
30 days. We know the mean and .
Specified Date, D Z Probability of completion
by D:
20
(20 -28)/3.07 ≈-2.6
0.005
25
(25 -28)/.07 ≈-1.0
0.159
30
(30 -28)/3.07≈0.6
0.726

01/01/2010 816
CPM
• Crashing of cost in CPM:
• CPM analysis assumes that ●The costs
associated with the project can be divided into
direct costs (direct material, direct labour…)and
indirect costs ( Overhead items like indirect
supplies, rent insurance, managerial
services….,) ● Activities of a project can be
expedited by crashing which involves employing
more resources, ● Crashing reduces
time but increases direct costs because of
factors like overtime payments, etc. and
decreases indirect costs.
01/01/2010 817
CPM
• The CPM analysis seeks to find ways of crashing
on total cost (= direct costs + indirect costs) and
also reduce the project duration.
• The procedure for this as follows:
• Obtain the critical path in the normal network and
determine the project duration and direct cost;
• Examine the cost –time slope of activities on the
critical path and crash the activity which has the
lest slope;
• Construct the new critical path after crashing as
above and determine project duration and cost;
• Repeat the two previous steps till activities on
the critical path are crashed.
01/01/2010 818
One example will clarify:
Normal and Crash time and Cost:
Time in weeks Cost
Activity

Normal Crash Normal Rs. Crash Rs.
Cost to
expedite,
per week
1 – 2 8 4 3000 6000 750
1 – 3 5 3 4000 8000 2000
2 – 4 9 6 4000 5500 500
3 – 5 7 5 2000 3200 600
2 – 5 5 1 8000 12000 1000
4 – 6 3 2 ½ 10000 11200 2400
5 – 6 6 2 4000 6800 700
6 – 7 10 7 6000 8700 900
5 – 7 9 5 4200 9000 1200
45200 70400

01/01/2010 819
The Project Net work:

2 4 6




1
7


3 5

The Critical path is 1 – 2 – 4 – 6 – 7, the duration is 30 days and the direct
cost is .Rs. 45200.
7
9 5
8
9 3
10
5
6
01/01/2010 820
From the table, we can see that the activity 2 – 4 has the lowest slope in the
critical path and hence that activity is crashed by 3 weeks, thereby reducing
the duration to 27 weeks. Now the changed network will look as follows:

2 4 6




1
7


3 5

The direct cost has increased to Rs.46700.
7
9 5
8
6 3
10
5
6
01/01/2010 821
Now the new Critical path is 1 – 2 – 5 -6 – 7 with duration 29 weeks and the
cost is Rs. Rs.46700.
Now the activity with the lowest slope is 5 – 6 and by crashing that , the direct
cost has gone up by Rs.2800 to Rs. 49500, but the duration is reduced by 4
weeks to 25 weeks.
So the network diagram now changes to :


2 4 6




1
7


3 5

7
9 5
8
6 3
10
5
2
01/01/2010 822
Now, the new critical path is 1 -2 - 4 -6 -7 with the duration 27 weeks and
direct cost Rs. 49500.
At this stage, activity 1 – 2 has the least slope and so that activity has to be
crashed by 4 weeks, thereby reducing the duration to 23 weeks and
increasing by the direct cost by Rs. 3000 to Rs. 52500.
Now the network will change to :

2 4 6




1
7


3 5
7
9 5
4
6 3
10
5 2
01/01/2010 823
And the new critical path is : 1 – 3 – 5 – 6 – 7 with duration 24 weeks and
direct cost Rs. 52500. You can see that the activity 3 – 5 in the critical path
has the least slope and by crashing the duration is reduced by 2 weeks to 22
weeks and the direct cost increases by Rs.1200 to Rs. 53700.
So the diagram changes to


2 4 6




1
7


3 5
5
9 5
4
6 3
10
7
5 2
01/01/2010 824
Now again the path 1 – 2 – 4 – 6 – 7 has become critical with duration23
weeks and direct cost Rs.53700. Now by crashing activity 6 – 7, we can
reduce the duration by 3 weeks to 20 by increasing the direct cost by Rs.
2700 to Rs.56400.
The new critical path is shown below.


2 4 6




1
7


3 5

5
9 5
4
6 3
7
5 2
01/01/2010 825
Now the critical path is 1 – 2 – 4 – 6 -7 with duration 20 weeks and direct cost
Rs. 56400.
Now the activity 4 – 6 can be crashed, resulting in reducing the duration by ½
week to 19 ½ weeks and increasing the direct cost by Rs. 1200 to Rs. 57600.
The new critical path is shown below.


2 4 6




1
7


3 5
5
9 5
4
6 2.5
7
5 2
01/01/2010 826
CPM
• We have now reached the final stage, where the
path 1 – 2 – 4 – 6 – 7 continues to be the critical
path with duration 19 ½ weeks and direct cost
Rs. 57600.
• You may observe that there is no more activity
left for crashing.
• In the final analysis, due to crashing of some
activities along the critical paths, the duration has
come to 19.5 weeks, the direct cost has gone up
to Rs. 57600 and the indirect cost has come
down to Rs. 39000 (from Rs. 60000).
01/01/2010 827
CPM
• So the total cost has come down to Rs. 57600 +
39000 = Rs. 96600 ( from Rs. 45200 + 60000
i.e. 105200 .

01/01/2010 828
Computer Applications in Project
Management
• The computer has now become a part of project
decision-making process. It has revolutionised the
working of the industrial and project management all
over the world.
• A lot of work has taken place on computer software.
The softwares that are available nowadays are user
friendly .
• A number of computer ‗languages‘ have been
developed based on the needs of the users.
• A lot of ‗Application Packages‘ have also been
developed.
• In projects, which are generally complex, lapses go
easily go unnoticed and as a result, wrong decisions
are made.
01/01/2010 829
Computer Applications in Project
Management
• Computers can help to avoid such pitfalls in all fields
of management.
• On any project with many activities, with
frequent updating, the computer cost will be
equal to the manual cost, but the speed,
reliability, versatility, Memory, accuracy and
other facilities will far outweigh the manual
process. Communication of the project strategy
can be common with one control document seen
by all.
• Project managers have to deal with uncertainties
and risks while scheduling activities and
allocating resources. In such cases, they have
to seek the probabilistic approaches.
01/01/2010 830
Computer Applications in Project
Management
• For example, the probabilistic aspect of critical-
path methods deals with the fact that the actual
duration of a project activity is usually a random
variable rather than a deterministic constant.
• Similar is the case with certain milestone events
where probabilistic branching of certain activities
to reach such events, should be considered.
• The Computer can aid the project management
by providing quick analysed info in any required
form, by doing the routine numerical problems at
great speed.
01/01/2010 831
Computer Applications in Project
Management
• In project management, in addition to the routine
info about the activities, activity schedules, activity
timings, key activities, the computer can give
detailed info about :
critical activities, critical events,
earliest and latest start and finishing times
of activities, critical path, slack, bar charts
of various departments, optimum time/cost,
allocation of resources, multi project schedules,
simulated PERT, bills outstanding,
location of equipment, financial info,
marketing info, key ratios etc.
01/01/2010 832
Computer Applications in Project
Management
• The revolution in computer has made project
management systems affordable and amenable to
projects of all sizes.
• After the microcomputers have been widely adopted
by the business community, abundant project
management software packages are now available.
• The software programmes support the planning and
control of such elements as work scope, contents of
a project, project timing, human resources,
budgeting, costs and communications. They also
compare the current status to the plan and so
helpful in monitoring the progress of the project and
its evaluation.
01/01/2010 833
Computer Applications in Project
Management
• Most of the WBS in project planning is now down by
the computer.
• The computer can support the project manager to
support the budgets task by task or by cost
categories, to plot the expenditure schedules and
cash flow plans.
• With the help of computers, one can reorganise the
activities, reschedule the tasks and do resource
planning in an iterative process to optimise the
schedule and resource plan.
• Tracking through the computer enables the
recording of how much work has been done, what
resources were utilised and what costs were
incurred.
01/01/2010 834
Computer Applications in Project
Management
• Artificial intelligence Expert System:
• Artificial Intelligence (AI) programmes involve
symbolic representation, symbolic inference,
and heuristic search.
• A new area of AI which is of particular interest to
project management is known as ‗Expert
System‘.
• An expert system is software that attempts to
reproduce the performance of one or more
human experts, most commonly in a specific
problem domain, and is a traditional application
and/or subfield of artificial intelligence.
01/01/2010 835
Computer Applications in Project
Management
• These programmes seek to solve practical
problems by imitating the process human
experts would follow.
• They can achieve a high level of performance in
tasks where human beings require years of
special education and experience.
• An expert system is also capable of drawing
conclusions without a predefined structure.
• It could perform the following functions:
• Monitor deviations from the planned schedule,
progress and analyse interrelations among the
various packages.
01/01/2010 836
Computer Applications in Project
Management
• Identify single potential schedule slippages. The
system would extrapolate effects of changes in
status, identify the affected items and classify
them in order of criticality.
• Pinpoint the needs for human intervention and
analysis.
• The AI based system would attempt to take
decisions on the basis of incomplete data, but
the expert system would identify the need for
data and show where human intervention would
be most effective.
01/01/2010 837
Computer Applications in Project
Management
• Show where to allocate special resources and
reserves.
• The system would extend schedule findings to
cost-to-complete by tracking cost factors
associated with work-packages. (A delay in one
would increase the cost of a later one.)
• Improve resource utilisation.
• The system would not only focus on the most
critical activities but would also point out
previously critical activities, which should be
relieved from the earlier imposed management
pressures or extra resources.
01/01/2010 838
Computer Applications in Project
Management
• Alternative resource schedules would be proposed
automatically and presented to the management for
decision.
• Multi-Project Scheduling: When several projects are
progressing simultaneously, computers are very
helpful in scheduling and allocating the resources
among the projects since the resources may be
drawn from the same common pool.
• Optimisation of the utilisation of resources is
achieved through the use of computers. The
resources in question may be skilled manpower,
staff, equipment, funds etc. which have to be
managed along many dimensions such as costs,
time and returns.
01/01/2010 839
Computer Applications in Project
Management
• Global projects, organised on a matrix basis can
be simulated to study the behaviour of client,
contractor, supplier, consultant, architect,
subcontractor, vendor, local project authorities,
local regulations, fund availability, coordination,
planning, control, monitoring, evaluation and
integrate the same from the organisation‘s
priorities.
• Computer PERT simulation:
• Simulation is very helpful in Project Management
especially in project planning through network
analysis for new product launching.
01/01/2010 840
Computer Applications in Project
Management
• Simulation is a quantitative technique used for
studying alternative course of action by building
a model of that system and then conducting a
series of repeated trials to predict the behaviour
of a system over a period of time. The desired
changes in system can be introduced for
studying their effects.
• Simulation can be used for evaluating capital
investment proposals by varying factors such as
market size, selling price, market growth rate,
market share, investment required, residual
value of investment, operating cost, fixed cost,
useful life of facilities etc.
01/01/2010 841
Computer Applications in Project
Management
• By simulating the network several times, each
time randomly selecting an activity time from
within its estimated ranges for each activity,
simulation enables the probability of an activity
being on critical path in advance and this helps
in allocating the resources in a better fashion.
• The accuracy of PERT simulation is more than
that of PERT. Random numbers generated by
the computer, which have equal chance of
representation in the sample are used to
simulate a sample.
01/01/2010 842
Computer Applications in Project
Management
• Project Managers are often faced with
considerable project uncertainties and risks and
they arise due to external factors (such as
government regulations, difficulties in financing
etc.) and internal factors ( site-location problems,
design alternatives etc.).
• There are also other constraints like
technological considerations. Network models
provide the means to model these types of
uncertainties.
01/01/2010 843
Computer Applications in Project
Management
• In particular, the computer network
simulation languages such as Q-GERT,
and SLAM provide the concepts of
probabilistic and conditional branching,
random activity times, and different nodal
release requirements for this purpose.
• This represents a significant modelling
improvement beyond the capabilities of
PERT and CPM type networks.
01/01/2010 844
Computer Applications in Project
Management
• Project Management Softwares:
• These are used in time critical allocations. A
multiplicity of project management software is
available today - each with varying approach of
performing certain basic functions of project
planning, scheduling, monitoring, control and
review.
• Now there are many project management
software packages available in India – some of
the well known are :PRISM, INSTAPLAN, PC-
Projaks, Proman, Harward Total Project
Manager, Quick Net.
01/01/2010 845
Computer Applications in Project
Management
• There are also other packages such as: Artemis
project, MAC project, Microtrak, plotrak, PERT
master, plantrak, primavision, PROB-PERt,
promis, super project expert, timeline, etc.
• At least 25 names of Project Softwares have
been listed in Wikipedia.
• Infogoal.com has the list of more than 400
Project Management Softwares.
• (See the information about some of the
softwares presently available in the Notes)

The things which I always want you to act on««but which you don¶t:
Read the portions in advance; Do not miss any class; Be attentive in the class; Seek clarifications when required; Read the topics dealt with in the class on the same day or discuss with your friends to enhance your understanding of the topic; ‡ Quickly revise all the covered portions at least once in a week. ‡ If you do all the above, µMy Good Wishes are Always with All of You¶ will definitely work. 2 01/01/2010 ‡ ‡ ‡ ‡ ‡

Index to Topics:
No
1. 2.

Name of Topic
Introduction, Scope and coverage Project Function in an organisation, Layout of Project Department, Role of Consultants in Project Management Project Identification ± Selection of product, identification of market, preparation of feasibility study/report Project formulation, Evaluation of risks, preparation of project report.

Slide Nos.:
11 - 62 63 -107

3.

110 147 148 ± 183
3

4.

01/01/2010

5

Selection of location and site of the project, Factors affecting location Policies of Central and State Governments towards location, Legal aspects of Project management Financial analysis-Profitability Analysis, Social Cost Benefit Analysis Budget and Cash Flows Materials Management in Project PlanningProcurement, storage and disposal

184 ± 219 220 ± 334

6

7 8 9

335 ± 423 424 -

10 Financing of the project ±Sources of Finance, Cost implications thereof
01/01/2010 4

1 Financial Institutions- Guidelines for funding 1 projects, Risk Analysis ± Sensitivity Analysis 1 Quantitative aspects of projects ± PERT/CPM, 2 Network analysis for monitoring of the project 1 Computer applications ± Selection of software 3 packages for application to Project Management

01/01/2010

5

Reference Books
1. SC : Project Management ± By S.Chaudhury; 2. PG : Text Book of Project Management ± By P.Gopalakrishnan and V E Ramamoorthy; 3. PC: Project Management ± By Prasanna Chandra (SeventhEdition, 2009/Sixth Edition); (Tata McGraw ±Hill Publishing Co. Ltd) ‡ 4. PM: Project Appraisal ± By P K Mattoo; ‡ 5. VD : Project Management ± By Vasant Desai (3rd revised Edition, 2008)- (Himalaya Publishing House);
01/01/2010 6

Reference Books«
‡ 6. IC: Project Management by ICFAI Centre for Management Research; ‡ 7. ICFAI : Finance Series- Project Management: Vol. I to V by ICFAI; ‡ 8.Project Management ± The Managerial Process : By Clifford F. Gray and Eric W. Larson-3rd Edition ±Tata McGraw Hill Education Pvt. Ltd.

01/01/2010

7

Useful Websites
‡ http://www.dipp.nic.in (Dept. Of Industrial Policy and Promotion, Govt. of India); ‡ http://www.india.gov.in (Government of India); ‡ http://www.rbi.org.in (Reserve Bank of India; ‡ www.ifciltd.com (Industrial Finance Corporation of India Ltd.); ‡ http://www.weforum.org (World Economic Forum, Geneva, Switzerland ‡ (www.icicibank.com (ICICI Bank Ltd.); ‡ www.idbi.com (IDBI Bank Ltd.); ‡ www.utimf.com (UTI Mutual Funds); ‡ www.utiventures.com (UTI Ventures Ltd.);
01/01/2010 8

Useful Websites....
‡ www.licindia.com (Life Insurance Corporation of India); ‡ www.nsic.co.in (National Small Industries Corporation Ltd.) ‡ www.sidbi.com (Small Industries Development Bank of India Ltd.); ‡ http://www.idfcpe.com/pages/main1.html and http://www.idfc.com ) (Infrastructure Development Finance Co. Ltd.-IDFC); ‡ www.eximbankindia.com (Export-Import Bank of India);

01/01/2010

9

Useful Websites....
‡ www.nabard.org (National Agricultural Bank for Rural Development-NABARD); ‡ http://www.worldbank.org/ (World Bank): ‡ http://www.microsoft.com/project/en/us/productinformation.aspx (Microsoft Office Project Professional ± Project Soft ware) --------------------------------------------------------------------------Total Marks: 100 (Internal Assessment: 40 marks + Final Written Examination : 60 marks) (Internal Assessment : $ Attendance : 10 marks + $ Presentations - Assignments of Teaching of topics to the class : 15 marks + $ Class Test : 15 marks. )
01/01/2010 10

Introduction: Project and Project Management ‡ ³Project Management is the business process of creating a unique product, service or result. A project is a finite endeavour having specific start and completion dates undertaken to create a quantifiable deliverable. Projects undergo progressive elaboration by developing in steps and predictable increments that are tied to benchmarks, milestones and completion dates.´ ‡ A Project is a specific activity on which money is spent in the expectation of returns. There is therefore a specific starting point, a specific end point and it is intended to achieve a specific objective.
01/01/2010 11

1.

1.Introduction: Project and Project Management
‡ Project is an organised programme of activity carried out to reach a defined goal, often of a non-recurring nature with a specified terminal point. ‡ It is a package of time-bound, scheduled and assembled activities dedicated to the attainment of a specific objective of successful completion of a work on time and within the allotted budget. ‡ Project is a one-shot, time-tested, goaldirected major undertaking requiring the commitment of varied skills and resources.
01/01/2010 12

1.Introduction: Project and Project Management
‡ Project is the whole complex of activities involved in using resources to gain benefits. ‡ Project is a system involving coordination of a number of interrelated activities to achieve a specific objective. ‡ Project Management Institute (PMI) : ³A Project is a temporary endeavour undertaken to create a unique product or service.´ ³Project Management is the application of knowledge , skills, tools and techniques to project activities in order to meet or exceed stakeholder needs and expectations.´
01/01/2010 13

1.Introduction: Project and Project Management
‡ The British Standard (1996) : ³Project is a unique set of coordinated activities, with definite starting and finishing points, undertaken by an individual or organisation to meet specific objectives within defined schedule, cost and performance parameters.´ ‡ Some examples of µprojects¶ are: relocating a factory, constructing national highways, organising the Olympics and constructing a hydro power generating facility.
01/01/2010 14

What is not a project?
‡ Emergency response to operations problems ± Callouts ± Repairs and troubleshooting ‡ Routine operations support ± Maintenance of equipment ± Minor modifications and tuning of equipment

1.Introduction: Project and Project Management
‡ This finite characteristic of projects stands in sharp contrast to processes, or operations, which are permanent or semi-permanent functional work to repetitively produce the same product or service. ‡ In practice, the management of these two systems is often found to be quite different, and as such requires the development of distinct technical skills and the adoption of a separate management philosophy.
01/01/2010 16

‡ PM is always customer specific.Introduction: Project and Project Management ‡ Project Management (PM) is quite unique. the requirements and constraints within which a project must be executed are stipulated by the customer. It calls for sharper tools of planning and control and improved ways of coping with human problems caused in a project setting.1. project control and human aspects of PM. 01/01/2010 17 . project planning. It involves issues like forms of project organisation. ‡ PM is complex.

PM is a teamwork.Introduction: Project and Project Management ‡ PM is always interdependent and inter-related. It will always strive to bring maximum benefit to the society with minimum cost within the shortest stipulated time frame. The management should be quick and flexible in dealing with ever-changing dynamic situations which pervade very many aspects of the society. ‡ In sum.1. 01/01/2010 18 . It will organise around a process that is essentially customeroriented.

1. ‡ To perform such unique tasks. organisations have to take up new tasks that they are not equipped to handle. 01/01/2010 19 .Introduction: Project and Project Management ‡ Generally. organisations adopt the project approach. Sometimes. ‡ These tasks are new to the organisation as they are not performed earlier or they may not be repeated in the future. The project approach is adopted when the existing systems in the parent organisation are not equipped to handle the new task. Organisational structures and processes are custom made to produce a specific product or service.

Specified time.Introduction: Project and Project Management ‡ Some of the characteristics of the tasks that qualify to be projects are: Unique activities.1. 01/01/2010 20 . Sequence of activities. Interrelated activities. Attainment of a specific goal.

Knowledge Areas: ‡ ‡ ‡ ‡ ‡ Scope Management Time Management Cost Management Quality Management Human Resources Management (Organizational Planning. Staff Acquisition. Team Development ) 01/01/2010 21 .Project Management .

Risk Quantification. Administrative Closure ) ‡ Risk Management (Risk Identification. Risk Response Control) 01/01/2010 22 . Information Distribution.Knowledge Areas«. Performance Reporting. ‡ Communications Management (Communications Planning. Risk Response Development.

Knowledge Areas«. Solicitation Planning. Source Selection. ‡ Procurement Management (Procurement Planning. Project Plan Execution Overall Change Control ) 01/01/2010 23 . Contract Close-out) ‡ Integration Management ( Project Plan Development. Contract Administration. Solicitation.

Leadership Skills: ‡ ‡ ‡ ‡ ‡ ‡ ‡ ‡ 01/01/2010 Vision and Strategy Establishing Direction Aligning People Communicating Negotiating Motivating and Inspiring Influencing Organizations Overcoming Barriers to Change 24 .

General Management Skills: ‡ ‡ ‡ ‡ ‡ ‡ ‡ ‡ ‡ 01/01/2010 Planning Finance and Accounting Personnel Administration Technology Organizational Development Delegation Team Building Conflict Management Solving Problems 25 .

Communications Skills: ‡ ‡ ‡ ‡ ‡ ‡ Writing Listening Speaking Presenting Media Relations Meeting Management 01/01/2010 26 .

Project Management ‡ The success of a project depends on the project manager¶s ability to strike a balance between these interrelated variables or constraints. D Time. Some of the common constraints that influence the project are: DScope. 01/01/2010 27 . DResources. D Cost. D Quality.

depending on the type of project. For example. such as how many passengers it can carry or how fast it should be able to travel. the scope could include the functional requirements of the plane. if the project was to design an airplane. ‡ Scope can involve a variety of things.Introduction: Scope and coverage ‡ µScope¶ of a project: ‡ A project management term for the combined objectives and requirements necessary to complete a project.1. 01/01/2010 28 . ‡ Properly defining the scope of a project allows a manager to estimate costs and the time required to finish the project.

allowing for smooth completion of the project. which occurs when the project gains additional features or requirements without extending the deadline. . ‡ This may be sidetracked by scope creep.Introduction: Scope and coverage ‡ It is the responsibility of the project manager to ensure that the scope's deadlines are met.1.

1. ‡ The tools and techniques for managing product scope vary with the nature of the project. ‡ The Product Scope details all the functions and features that are to be included in a product or service of a product whereas the Project Scope details the work to be done to deliver a required product with specific features. .Introduction: Scope and coverage ‡ The Scope of a project can be divided into two parts: µProduct Scope¶ and µProject Scope¶.

Scope Management: ‡ ‡ ‡ ‡ ‡ Initiation Scope Planning Scope Definition Scope Verification Scope Change Control 01/01/2010 31 .

Scope Management: ‡ Project Planning : Components: $What ? : Work Breakdown Structure. $ Who? : Organisation Breakdown Structure. . $ When? : Schedule. $ How? : Plans and Specifications. $ How Much?: Cost Breakdown Structure (Via Estimates).

resources that will be consumed and the end-products from the successful completion of the project. Sometimes the term scope is used to mean the totality of work needed to complete a project.Introduction: Scope and coverage ‡ In PM. ‡ Scope describes all the activities that are to be performed. 01/01/2010 33 . the scope of a project is the sum total of all of its products and their requirements or features. ‡ Scope is a brief and accurate description of the end-products or deliverables to be expected from the project that meet the requirements.1. including quality standards.

Introduction: Scope Statement ‡ The scope also includes the target outcomes. ‡ Scope Planning/Statement: Scope Planning involves the development of the Scope Statement. prospective customers. outputs. 01/01/2010 34 . financial and human resources required to complete the project. ‡ The Project Manager uses tools like product analysis. cost/benefit analysis. and expert judgment to develop the scope of a project. work.1.

01/01/2010 35 . ‡ Scope statements may take many forms depending on the type of project being implemented and the nature of the organization. the tools to describe a project's scope (product) are the product breakdown structure and product descriptions.Introduction: Scope Statement ‡ In traditional PM. ‡ The primary tool to describe a project's scope (work) is the work breakdown structure.1.

The objectives should include measurable success criteria for the project. ‡ µDeliverables¶ is a Project Management term for the quantifiable goods or services that will be provided upon the completion of a project. 01/01/2010 36 . and are often specified functions or characteristics of the project. ‡ Deliverables can be tangible or intangible parts of the development process.Introduction: Scope Statement ‡ The scope statement details the project deliverables and describes the major objectives.1.

It provides a preliminary delineation of roles and responsibilities.1. objectives and participants in a project. scope statements should contain: The project name The project charter (A project charter or project definition -sometimes called the terms of reference-.«« .Introduction: Scope Statement ‡ As a baseline.is a statement of the scope.

outlines the project objectives. sponsors. identifies the main stakeholders.1.Introduction: Scope Statement «. It serves as a reference of authority for the future of the project. and stakeholders  The problem statement  The project goals and objectives 01/01/2010 38 .) The project owner. and defines the authority of the project manager.

a product breakdown structure (PBS) is an exhaustive.1. arranged in whole-part relationship. ‡ A PBS can help clarify what is to be delivered by the project and can help build a Work Breakdown Structure (WBS). 01/01/2010 39 . hierarchical tree structure of components that make up an item.Introduction: Scope StatementProduct Breakdown Structure (PBS) The project requirements The project deliverables The project non-goals (what is out of scope) Milestones Cost estimates ‡ In PM.

control and organisation of a project.1. It covers the management. an independent office of HM Treasury of the United Kingdom. part of which is developing a product breakdown structure.Introduction: Scope Statement-PBS ‡ The PRINCE2 project management method mandates the use of product based planning. ‡ PRojects IN Controlled Environments (PRINCE) is a project management method. "PRINCE2" refers to the second major version of this method and is a registered trademark of the Office of Government Commerce (OGC). 01/01/2010 40 .

‡ PRINCE2 describes procedures to coordinate people and activities in a project. ‡ In the method each process is specified with its key inputs and outputs and with specific goals and activities to be carried out. how to design and supervise the project. and what to do if the project has to be adjusted if it doesn¶t develop as planned. ‡ It provides a method for managing projects within a clearly defined framework. . which gives an automatic control of any deviations from the plan.PRINCE2 ‡ PRINCE2 is a structured approach to project management.

Figure of a PRINCE2 process model 01/01/2010 42 .

--Housing.1. Monitor : --CRT. --Motherboard : CPU. --Network card. . --Video card. . --LPT port card. --Electronic components 01/01/2010 43 .. -. --HDD.FDD.--Sound card.. ‡ RAM chips.Introduction: Scope Statement-PBS ‡ Example : PBS of a computer: Main unit : -Housing.

Keyboard ‡ A WBS in project management and systems engineering.Introduction: Scope StatementWork Breakdown Structure (WBS) Mouse : --Body. is a tool that defines a project and groups the project¶s discrete work elements in a way that helps organize and define the total work scope of the project.1. 01/01/2010 44 .. --Marble. --Cable«.

project. 01/01/2010 45 . which shows a subdivision of effort required to achieve an objective.Introduction: Scope Statement-WBS ‡ A WBS element may be a product. and contract. a service. for example a program. WBS also provides the necessary framework for detailed cost estimating and control along with providing guidance for schedule development and control. ‡ The WBS is a tree structure. or any combination. ‡ Additionally the WBS is a dynamic tool and can be revised and updated as needed by the project manager.1. data.

the WBS is developed by starting with : ± the end objective and ± successively subdividing it into manageable components ± in terms of size. service. and work packages) ± which include all steps necessary to achieve the objective. 01/01/2010 46 . In a project of contract.Introduction: Scope Statement-WBS ‡ The WBS may show hardware. duration. subsystems.g. tasks. subtasks. components.1. and responsibility (e. product. or may be process oriented.. systems.

materials.1. schedule.. 01/01/2010 47 .Introduction: Scope Statement-WBS ‡ The WBS provides a common framework for the natural development of the overall planning and control of a contract and is the basis for dividing work into definable increments from which the statement of work can be developed and technical. into their successively higher level ³parent´ tasks. etc. materials. and labour hour reporting can be established. etc. ‡ A WBS permits summing of subordinate costs for tasks. cost.

01/01/2010 48 .Introduction: Scope Statement-WBS ‡ For each element of the WBS. a description of the task to be performed is generated. It is instead a comprehensive classification of project scope. ‡ A WBS is not an exhaustive list of work.1. ‡ A WBS is not a project plan or a project schedule and it is not a chronological listing. ‡ This technique (sometimes called a System Breakdown Structure) is used to define and organize the total scope of a project.

g. using project management software) before designing a proper WBS. ‡ This would be similar to scheduling the activities of home construction before completing the house design. it is very difficult to follow the 100% Rule at all levels of the WBS hierarchy. (See the 100% rule elaborated in the notes). ‡ Without concentrating on planned outcomes. 01/01/2010 49 .Introduction: Scope Statement-WBS ‡ It is considered poor practice to construct a project schedule (e.1.

‡ The best way to adhere to the 100% Rule is to define WBS elements in terms of outcomes or results. ‡ This also ensures that the WBS is not overly prescriptive of methods.1. he/she will likely include either too many actions or too few actions.Introduction: Scope Statement-WBS ‡ If the WBS designer attempts to capture any action-oriented details in the WBS. ‡ Too many actions will exceed 100% of the parent's scope and too few will fall short of 100% of the parent's scope. 01/01/2010 50 .

Introduction: Scope Statement-WBS ‡ Mutually exclusive elements : In addition to the 100% Rule. ‡ Likewise. such overlap is likely to cause confusion regarding project cost accounting. ‡ This ambiguity could result in duplicated work or miscommunications about responsibility and authority. ‡ A WBS is not an organizational hierarchy.1. 01/01/2010 51 . it is important that there is no overlap in scope definition between two elements of a WBS.

‡ WBS updates. This is another reason why a WBS should be outcome-oriented and not be prescriptive of methods. a WBS that shadows the organizational structure is not descriptive of the project scope and is not outcome-oriented. ‡ While it is common for responsibility to be assigned to organizational elements.1. 01/01/2010 52 .Introduction: Scope Statement-WBS ‡ Some practitioners make the mistake of creating a WBS that shadows the organizational chart. require formal change control. other than progressive elaboration of details.

‡ Scope Management Plan is one of the major Scope communication documents.1. but changes in planned outcomes require a higher degree of formality. change control may be too rigid for actions and too informal for outcomes. ‡ If outcomes and actions are blended. Nor is it a strategy map. ‡ A WBS is not a logic model. 01/01/2010 53 .Introduction: Scope Management Plan ‡ Methods can. and do change frequently.

verified and communicated to the project team and stakeholders/customers. ‡ It also includes all work required to complete the project. 01/01/2010 54 . ‡ The Project Scope Management plan is included in as one of the sections in the overall Project Management plan.1.Introduction: Scope Management Plan ‡ The Project Scope Management Plan documents how the project scope will be defined. ‡ The documents are used to control what is in and out of the scope of the project. controlled. managed.

. 01/01/2010 55 . ««. ‡ Product Analysis is a technique for understanding the features and functions of a product.Introduction: Scope Management Plan ‡ It can be very detailed and formal or loosely framed and informal. the project manager can define the scope of the project more precisely. ‡ Techniques like µValue Analysis¶ and µQuality Function Deployment¶ help the Project Manager gain more information regarding the project.1. ‡ By enhancing the level of his knowledge of the project¶s product. depending on the communication needs of the project. {Value engineering (VE) is a systematic method to improve the "value" of goods and services by using an examination of function.

1. and ultimately to specific elements of the manufacturing process.Introduction: Scope Management Plan ««. Yoji Akao. when the author combined his work in quality assurance and quality control points with function deployment used in Value Engineering.as described by Dr. and "value analysis" (VA)} {Quality function deployment (QFD) is a ³method to transform user demands into design quality. to deploy the functions forming quality.} 01/01/2010 56 . and to deploy methods for achieving the design quality into subsystems and component parts.´.Value engineering is also referred to as "value management" or "value methodology" (VM). who originally developed QFD in Japan in 1966.

1. (See more in notes from Wikipedia) 01/01/2010 57 . ‡ QFD helps transform customer needs (the voice of the customer [VOC]) into engineering characteristics (and appropriate test methods) for a product or service. prioritizing each product or service characteristic while simultaneously setting development targets for product or service. The technique yields graphs and matrices. company. or technology-development needs.Introduction: Project phases ‡ QFD is designed to help planners focus on characteristics of a new or existing product or service from the viewpoints of market segments.

‡ You may also look at the project activities as Pre-project and post-project and break them into several stages for a clear understanding of the tasks involved in a project.Definition phase. 3. 2. 01/01/2010 58 . 5.Project phases ‡ PM can be divided into six phases: ‡ Initiation phase.Follow-up phase.Design phase.Development phase.Implementation phase and 6. 4.

Introduction: Project phases ‡ Pre-project activities may be generally broken down as: Conceptualising Market Survey. 01/01/2010 59 . market location or area targeted. feasibility study and expansion plans giving final picture Focussing with respect to quality. and a balance amongst these Basic engineering and extended basic engineering considering local condition«.. capacity or product mix with capacities Site selection. infrastructural facilities. finished goods. taking into consideration availability of raw materials.1.

transportation and insurance etc. 01/01/2010 60 . Detailed engineering and statutory documentation preparation for required approvals from various bodies.Introduction: Project phases «. safety and security Procurement.. ‡ The Post-project activities may be similarly broken down into the following activities: ‡ Stabilising the process parameters and instrument settings«. erection and pre-commissioning activities Commissioning Performance trials and commercial production..1.

maintenance and safety staff Compilation of all operating and maintenance manuals. drawings and technical details. paintings etc.Introduction: Project phases «. commissioning and stabilising operations including field changes. and all the operating disciplines Training of operation.. Preparation of µas±built¶ drawings. catalogues. 01/01/2010 61 . incorporating all the changes/ modifications made during execution. drains.«. plastering. in an easily retrievable manner including guarantees for equipments Awareness programmes for quality and safety Monitoring balance erection work such as roads.1.

01/01/2010 62 .Introduction: Project phases «. Finalising contractors¶ bills and sorting out disputes with suppliers and contractors Sitecleaning and housekeeping Storage of spares with proper inventory and security.1.

responsibilities. 01/01/2010 63 . and assigning project roles. Organising Project Dept.2.  Choosing an appropriate organisational structure facilitates the effective implementation of an organisational plan. and reporting relationships.  Organisational planning of Project Dept.  Organisational planning is a process of identifying. documenting.:  An organisation can be defined as a group of individuals who coordinate their activities in order to accomplish a business and /or social objective.

availability of resources. the product/services sold. ‡ Developing an organisational structure also helps in delegating tasks with responsibility and accountability. competition and other decision making requirements. 01/01/2010 64 . ‡ The structure of an organisation is dependent on parameters like the rate of change of technology. Organising Project Dept.2. ‡ The individuals or groups who may be a part of the organisation or may be external to it.

‡ A project manager¶s choice of organisational structure depends on the nature of the project and the degree of control required for its implementation.2. ‡ Some of the organisational structures that a project manager can consider are:  Traditional Organisational Structure  Pure PRODUCT Organisational Structure  Pure PROJECT Organisational Structure  Matrix Organisational Structure. Organising Project Dept. 01/01/2010 65 .

control and monitor the work through the functional manager. Organising Project Dept. ‡ The Traditional Organisational Structure is developed around the functional aspects of the organisation such as engineering. the project manager may have to assign. marketing. because of his lack of authority in the functional department. 01/01/2010 66 . when different departments have to be coordinated. manufacturing. human resource and information systems.2. ‡ While Projects in individual functional departments do not face any problems.

‡ Some of the advantages and disadvantages of the Traditional structure are as follows Advantages Easy control.2. budgeting procedures Disadvantages No single person is responsible for the total project ± lack of authority and hence reduced motivation and innovation 01/01/2010 67 . Organising Project Dept.

ideas are function oriented and not project-oriented²difficulty in achieving tasks Flexibility in Complex coordinating system² use of broad consumes more time in approving the manpower decisions Continuity in Possibility of partiality in decision functional making disciplines 01/01/2010 68 .Sharing of knowledge and responsibility and grouping of specialists Project-oriented emphasis is absent and hence lacks customer focus and slow in responding to customers¶ needs.

2. Organising Project Dept. Reporting structure with Lack of proper projectgood control over oriented planning and people authority-leads to difficulty in pinpointing responsibilities. Quick reactions to situations depending upon the functional manager¶s priority. 01/01/2010 69 .

‡ The basic advantage of this structure is the individual line of authority. a single individual has the authority to control the entire activity. Organising Project Dept.2. ‡ Pure Product Organisational Structure is developed on the basis of managing individual products as functional departments. Each individual product is assigned a product manager who has functional specialists to assist him. i. ‡ Its narrow reporting structure helps develop a strong communication channel along with accelerated feedback. 01/01/2010 70 .e.

Disadvantages Duplication of efforts. facilities and personnel ± leading to prohibitive costs of maintenance in multi-product organisations Direct link between Retains personnel in projects the project manager longer than necessary and other stakeholders 01/01/2010 71 Advantages Enables strong control because of single project authority .2. Organising Project Dept.

Develops strong Firm¶s progress is hindered communication by the lack of strong channels functional groups and technology Maintains project Controlling functional expertise without specialists requires top level sharing key coordination personnel Facilitates speedy Technology is not shared reactions to among projects situations 01/01/2010 72 .

2. Organising Project Dept. Facilitates loyalty of team No career members towards project prospects for the project team Retains attention on customer relations Enhances decision making efficiency of senior management 01/01/2010 73 .

Organising Project Dept. ‡ Pure Project Organisational Structure: Organisations working on large and long-term projects usually adopt pure project organisational structure. ‡ This is a vertical organisational structure which avoids conflicts and problems faced by the traditional and product organisational structures.2. 01/01/2010 74 . ‡ This type of organisation structure contains functional departments within the individual projects. ‡ All the team members contribute on full time basis.

Advantages Disadvantages The Project Manager has complete Inefficiency in resource authority over the project utilisation The Project Manager has the Duplication of facilities freedom to acquire the resources needed for the project¶s progress The Project team reports directly to the Project Manager ± thus develops a formal communication channel between the Project Manager and his team 01/01/2010 Sourcing personnel from internal functional departments to work on the project affects work in the functional departments 75 .

Organising Project Dept.2. The Project personnel are shared between the project and the project organisation Facilitates unity of command 01/01/2010 76 .

‡ Every project is treated as profit centre. ‡ It is suitable for project driven organisations like software development firms. Hence the GM directly assigns power and authority to the Project Manager to handle the project«« 01/01/2010 77 . Organising Project Dept. ‡ It makes the Project Manager totally responsible and accountable for the success for a project. ‡ The Matrix Organisational Structure: A Matrix organisational structure is formed as a result of combining the advantages of all the aforementioned organisational structures.2.

e.The Project Manager is responsible for the technical excellence of the functional departments in managing the departments. 01/01/2010 78 . it shares the information and personnel while executing the project.2. ‡ The strength of the structure depends on the level of control that the Project Manager is able to exercise over the functional resources. ‡ The primary objective of the Matrix organisational structure is to derive synergy through shared responsibility between the project and functional management. Organising Project Dept. ‡ This structure functions in a collaborative manner ± i. ‡ ««.

‡ Advantages of the Matrix organisational structure: Enables the Project Manager to exercise control over all the resources Every project has its own independent set of policies and procedures Authorises the Project Manager to commit the company resources ensuring that scheduling does not clash with other projects Facilitates quick response to conflicts. changes and other project needs 01/01/2010 79 .2. Organising Project Dept.

Organising Project Dept. Derives support of the functional department to the project Enables proper HR Development by enhancing the career prospects of team members Facilitates cost minimisation by sharing key personnel Facilitates spending more time to solve complex problems Develops a strong technical base Eases solving of the problems that require top management involvement 01/01/2010 80 .2.

2. Minimises conflicts Ensures optimum balance among time cost and performance Enables authority and responsibility sharing ‡ There are some pre-conditions to be fulfilled for a Matrix Organisation Structure to be established. They are: It should be ensured that : All the team members commit to spend full time on the project Conflicts are resolved quickly««. Organising Project Dept. 01/01/2010 81 .

2. The resources are negotiated with function and project oriented managers The functional departments function as individual entities ‡ It is observed that the following are the situations which favour the implementation of the Matrix structure: The primary output of an organisation is a complex product The organisation serves multiple customers in different geographical locations 01/01/2010 82 . Organising Project Dept.

A project with complex design that requires innovation is to be finished on time Large amounts of data are required to be processed Designing. developing and testing a product requires sophisticated skills Resources have to be shared among different projects The market conditions demand rapid changes in the product 01/01/2010 83 .2. Organising Project Dept.

i / r ) i ilit i r j t .A i r ti r r t ti f tri r i ti l tr t r r l r r l Adm n. nager anager r duc ti n anager a r e t in g / a le s anager in a n c e anager rti r iz l ti r l t l i i i l i t / ri fr ti l l ti t t . ( r j i ilit i . rt 01/01/2010 84 .

Balanced and Strong. . Organising Project Dept.2. ‡ Refer to Book by Gray and Larson and Explain these three forms. ‡ There are three types of Matrix organisations ± Weak.

2. ‡ Selecting an organisational structure: PM has become a specialised field due to the need for implementing complex and large projects within the defined constraints of time. 01/01/2010 86 . ‡ The traditional organisational structure have proved to be ineffective to deal with the complexities of Project Management. Organising Project Dept. performance and profit. cost. ‡ Therefore it is necessary for organisations to identify the most appropriate organisational structure for the successful execution of a project.

2. availability of resources uniqueness of the project. experience of the organisation in managing projects and transparency at the senior management level 01/01/2010 87 . duration of the project. ‡ The parameters to be considered while selecting the type of organisational structure may generally include: size of the project. physical location of the project. Organising Project Dept.

4. Organising Project Dept. Need for integration (number of departments involved. Budget and time constraints and Stability of resource requirements. 5. ‡ 1. 3. 6. . Novelty and need for innovation. Strategic importance.2. the following seven factors influence the choice of PM structure: Size of Project. 7. 2. According to Hobbs and Menard. Environmental complexity.

2. 01/01/2010 89 . Organising Project Dept. ‡ The Project Management Organisational Structure: Every type of organisational structure has its advantages and disadvantages. The Project Management approach proves to be an effective alternative with minimum disadvantages.

Project Management Organisational Structure Advantages Disadvantages Effective project control Lack of consistency in applying company policies Improved relationship Under utilisation of personnel with customers Ability to develop Low profit margins products faster Minimum programme Increases complexity of cost internal operations Improved quality and High transfer rate of reliability personnel among projects Enhanced profit margins Duplication of functional skills 01/01/2010 90 .

. ..Advantages«. Effective and efficient control on the security of the programme Improved result orientation Effective coordination among the divisions working on the project Improved morale and goal orientation among employees 01/01/2010 91 . Disadvantages.

‡ The Project Management structure brings in an upgradation of jobs and job profiles. ‡ It should be borne in mind that the change over to the Project Management structure is a huge forward leap and going back to the traditional structure is not possible. Organising Project Dept. ‡ The µRight People for the Right Jobs¶ have to be identified and engaged for the success of the project.2. ‡ After selecting the appropriate structure. 01/01/2010 92 . it is necessary to select the personnel required to work on the project.

highways/roads. Whether it be telecommunications. the development of Infrastructure has gained topmost priority. water supply or sewerage disposal. Role of Consultants ‡ Role of Consultants in Project Management: As the economic growth is more than the development of Infrastructure in India in particular and Asia in general. all are lagging far behind the ideal levels of development as envisaged under the µCMP¶ (Common Minimum Programme). 01/01/2010 93 .2. power. airports. seaports.

Role of Consultants The Government in the 11th Five Year (20072012) has increased the outlay in Infrastructure significantly to Rs.8.2. 01/01/2010 94 .58.17.5 Billion) from the 10th Plan figures Rs. The major thrust areas for these investments will be in Power.000 Crores (US$ 203 Billion) at 2006-07 Prices.15.000 Crores (US$ 439. Roads and Railways which account for 2/3rd of the plan outlay in Infrastructure.

Role of Consultants India¶s Infrastructure investment requirements until 2010-2011. which includes investments in the transport.2. is estimated to be about $425 billion. energy. telecommunications. Of this total. (Study by the International Project Finance Association-IPFA) 01/01/2010 95 . and urban sectors. there is a $123 billion anticipated financing gap which is being sought from the Private Sector.

India needs to finance the infrastructure sector in trillions of rupees.  Project Management consulting is one of the growing consultation businesses since.2. Role of Consultants  To achieve and sustain the required level of growth. to eliminate risk. 01/01/2010 96 . more and more companies seek the services of consultancy firms for their project needs.  Consultation has become a good business these days and all they require to run business is to acquire experienced employees from different fields.  In this context. some Consultants specialise in managing these project operations. before starting any projects.

fees payable etc. need to be discussed and finalised.2. Role of Consultants Even big companies prefer to hire consultancy firms though they have to pay more. 01/01/2010 97 . deadlines for completion of the project. Selecting a consultancy firm for project management is a little time consuming task as research is needed to find out which project management consultancy is the best for the particular project and even after selecting a consultancy.

.2. for a key team member to be appointed as manager for a business critical project. Role of Consultants ‡ ³It is common today. 01/01/2010 98 . ‡ This individual normally has excellent ³technical´ knowledge of the project..... to project manage professionally? ‡ The statistics suggest probably not.... ‡ Most project management surveys in the last decade indicate that many projects fail to successfully meet their objectives. do they have the systems.. ‡ The million $ question is. competence and available time..

and lost profits that result. PRINCE. with mixed success. ‡ Those companies who have recognised the potential for savings have employed dedicated Project Managers. advantaged competitors. PMI. either interim or on the payroll.2. Role of Consultants ‡ «««« ± just think of the disappointed customers. 01/01/2010 99 . and the like. ‡ Recruitment is the first challenge ± what do you look for? Many business leaders have heard of qualifications such as APM. but are not sure what they mean.

2. ‡ Integration into the business is the next problem: ± are there suitable project management processes and tools/templates in existence in the business to be used? -.or are the Project Managers (PM) left to their own devices? ‡ The final big challenge is performance. ‡ Are the PMs delivering as well as they could and should? 01/01/2010 100 . Role of Consultants ‡ Nor do they understand the relevance and appropriateness for their business.

This need is often overlooked.´ ‡ This is where the professional Project Management Consultant comes in to perform and deliver the targeted results. 01/01/2010 101 . Role of Consultants ‡ There is a clear need for a framework of measurement and improvement.2.

generating new sources of revenues to finance the infrastructure are some of the critical areas where consultants can provide workable solutions. environmental consideration plays a very significant role in development projects. 01/01/2010 102 .  (See more details in the Notes)  As a result. and especially if they are funded by the international lending agencies like the IBRD or the ADB.2. Role of Consultants  Pricing and cost recovery.  The 1992 UN Conference on Environment and Development helped to put sustainable development on the agenda. particularly those relating to infrastructure.

suggesting the measures for their mitigation and identifying the economic costs of environmental degradation. 01/01/2010 103 . so that pricing of infrastructure services takes these costs into account. Role of Consultants Management consultants can meet the challenge of balancing economic and environmental considerations in practice.2. by assessing the environmental impacts.

Role of Consultants Consultants can play a significant role in the transformation process. There is a lot of scope for the consultant to support the setting up of legal and organisation structures to meet the needs and objectives of the public sector in this regard. 01/01/2010 104 .2. by acting as an interface between the bureaucratic government and the investors waiting for the unsaturated giant market to wake up.

efficient and economical administrative machinery. it is essential to have suitable organisation structures. which is creative and adaptable to the dynamic forces of the future. 01/01/2010 105 . human resources policies. Role of Consultants To develop and sustain an effective. which should strive to motivate the employees and at the same time satisfy the public at large. and systems and procedures. The government¶s lack of effective initiatives in framing an investment-friendly and transparent framework have kept even the genuine investors away and confused.2.

Consultants can precisely fill this gap by providing a multi-disciplinary. 01/01/2010 106 . and new capabilities through the economy. rapidly dispersing new knowledge. Management consultancy is about effecting change. new skills. multi ±functional and multi-sector think-tank matured with the experience acquired over the years.2. a catalyst and a multiplier. Role of Consultants Therefore there is an urgent need to have a pool of knowledge systems which would have credibility with the government as well as with the investors. It is in effect.

Role of Consultants Consultants can help to develop a systematic approach to evaluating the range of institutional options in the infrastructure sectors to take stock of the lessons or experience and identify best practices. and have to give way to more creative solutions. 01/01/2010 107 . It would be worthwhile making consultants intellectual partners in the effort.2. The challenges from the environment are such that conventional wisdom and approaches may not suffice. and to accelerate and focus the learning process.

including thrust areas for investment. norms for setting up projects and financing them. and the regulatory framework-including centre-state matters. liaison and documentation. covering scouting. environmental and sociological issues.2. feasibility and modalities. organisations involved. the consultants take care of the variety of tasks in the management of a project. 01/01/2010 108 . Role of Consultants In short. such as project formulation. and sectoral expertise. Advisory services. which can be generally summarised as follows: Policy and institutional framework.

debt and/or equity participation. Thus the consultants with their expertise in all the areas related to project executions and a clinical professional approach. Techno-sociological management synergy. community. to bring about collaborative efforts of specialists. both domestic and foreign.2. 01/01/2010 109 . government and other stake holders. play a very important role in Project Management. Role of Consultants Financing mechanisms. and alliances. including government. for stakeholders.

Project Identification : Selection of product Selection of a Project: A Project or Projects selected should be integrated with the Strategic Plan of the Organisation. The Strategic Management Process: ³What we are?´ ³What we intend to be?´ ³How we are going to get there?´ 01/01/2010 110 .3. ‡ Project Management is at the apex of strategy and operations. ‡ The Project Managers need to understand the Organisation¶s Mission and Strategy.

3. yAnalyse and formulate strategies to reach objectives and yImplement strategies through projects. ySet long-range goals and objectives. yMission statements may change«.Project Identification : Selection of product Four activities of the Strategic Management Process: yReview and define the organisational Mission. .Then the whole strategy has to also change accordingly.

Make the objective Assignable to one person for completion. Establish a Measurable indicators(s) of progress.3.Project Identification : Selection of product ‡ Characteristics of the objectives ³SMART´: Be Specific in targeting an objective. . that is (Time) duration. (or Achievable) State what can Realistically be done with the available resources and State when the objectives can be achieved.

Project Identification : Selection of product ‡ Effective Project Portfolio Management System: ØAvoids THE IMPLEMENTATION GAPS. ØAvoids ORGANISATION POLITICS and ØManages RSOURCE CONFLICTS AND MULTITASKING. .3.

Operational (Improving efficiency of the existing systems) and Strategic. .3.Project Identification : Selection of product ‡ Classification of the Projects: Compliance (and must do) (Regulatory or Emergency).

. $to prevent government intervention and regulation. $to make it difficult for competitors to enter the market.Criteria: Financial and Non financial: $ To capture larger market share. $to reduce dependency on unreliable suppliers.Project Identification : Selection of product ‡ Selection of Projects . $to develop complementary products $to develop core technology for use in next generation products.3.

3.Project Identification : Selection of product Selection of Product: The search for promising project ideas is the first step towards establishing a successful venture.  Theoretically.  The key to success lies in getting into the right business at the right time. .  The identification and implementation of good ideas contributes significantly to the success of a project. a number of projects are available for any entrepreneur.

new technologies.  The Project Manager¶s innovative efforts have to take into account the ever changing customerneeds and preferences. 01/01/2010 117 . and the existing and future potential competition. creativity.3. the speed at which the products and their technologies become obsolete. sensitivity to the dynamic external environment and a realistic assessment of the firm¶s capabilities.Project Identification : Selection of product  The generation of ideas and opportunities requires imagination.

01/01/2010 118 .3. location.Project Identification : Selection of product  The important dimensions which are to be probed thoroughly before making the choice are: Product/service. compilation and analysis of economic data for the eventual purpose of locating possible opportunities for investment and for the development of such opportunities. scale of production. market.  Do you recall Porter now?  Project identification is also concerned with collection. equipment. technology. incentives available and time phasing.

or the Public.Porter¶s 5 Forces Analysis There is also the sixth force-The µComplementor¶ . 119 01/01/2010 .the word coined by Andrew Grove to denote the Govt.

which enable the decision-maker to better utilise the resources without in any way changing the character of business. lead to a certain amount of change in the existing structure. create minimum disturbance to the existing state of affairs and hence the least risk.Project Identification : Selection of product  Drucker classifies the opportunities into three kinds: Additive . and so.3. and 01/01/2010 120 . Complementary ± introduction of new ideas.

Project Identification : Selection of product Breakthrough ± fundamental changes in both the structure and character of business. so is the requirement of more precise definition of the scope and nature of the project objectives and the necessity to select the best possible approach so as to minimise the resource consumption and risks and to optimise the return or gains. 01/01/2010 121 .  Risk is greater in the µcomplementary¶ but the most in the µbreakthrough¶.3.  As the risk increases.

"The availability of a specified type of raw material (Presence of a skilled artisans in an area«).) "Analysis of the performance of the existing industries: profitability.Project Identification : Selection of product ‡ New ideas for projects are thrown up by many situations. capacity utilisation« 01/01/2010 122 . "Observation of the existing processes (Eg. like magazine articles etc.3. Some examples are: "The dearth of a particular product or service. A factory using a particular machine deciding to manufacture the machine itself.

Project Identification : Selection of product "Examination of the inputs (availability.) "The statistics given by the magazines about the availability of various products..3. wastes«) "Review of Imports and exports (trend. "Research Institutes (CSIR etc«new technologies. time lag. economies of scale«). processes etc«). transportation costs. import substitution«. products which have export potential«. outputs (resultant by products. 01/01/2010 123 .

various incentives available. (Annual Publication µGuidelines to Industries¶ by the Dept.Project Identification : Selection of product "The Plan document and various departmental publications of the Government. future scope«) "Studies of the State Financial Institutions and Development Agencies: (Feasibility studies for establishment of new industries in various areas in their states«) 01/01/2010 124 . licensed and installed capacity. of Industrial Development: Structure. production performance.3. location. exports.

Project Identification : Selection of product "Study of the reports of the different Product Group Manufacturers¶/ Industries¶ Associations. "Products reserved for the SSI/SME sector listed by the Governments for their exclusive purchases. "Analysis of Economic and social trends: (changing habits of people to use more and more sophisticated products. indulging in leisure activities«) "Consumption of products in foreign countries which can fulfil the needs of the local public.3. 01/01/2010 125 . "Study of sick units for possibility of revival.

‡ A good project contains four critical elements: ³The right project at the right time at the right place and at the right price´. 01/01/2010 126 . ‡ If the entrepreneur himself has adequate experience in the manufacture and marketing of certain products. subject to the other criteria being fulfilled. then it would be to his advantage to select the product/s.3.Project Identification : Selection of product ‡ The entrepreneur is concerned with identifying a particular product that can be marketed successfully at a reasonable profit.

Rapid Growth.Project Identification : Selection of product Identifying the market: ‡ Out of the many project ideas thrown up from different sources as discussed above. ‡ The market can be identified from some of the sources indicated for selecting the project.3. Maturity or Stabilisation and finally the Decline). 01/01/2010 127 . the market for the product has to be identified. ‡ A short list may be made of only those products which can satisfy the Michael Porter¶s 5 force model and the Life Cycle approach ( Stages of a product : Pioneering or Infant.

ruling prices.Project Identification : Selection of product ‡ ³One should either identify a need and fill it or create a need and fill it´. sex will indicate the potential market. disposable incomes. geographical locations. ‡ The classification of the consumers on the basis of income groups. demography (age groups). industries. ‡ Seasonal factors.3. 01/01/2010 128 . fashion also indicate the potential market.

the outputs and the process involved in each activity. the inputs.3. the tasks that must be performed to achieve the objectives. 01/01/2010 129 .Project Identification : Selection of product ‡ The study of the project idea is the starting point of the feasibility analysis -.which is undertaken to identify the logic of the project.

‡ A feasibility study is an analysis of the viability of an idea through a disciplined and documented process of thinking through the idea from its logical beginning to its logical end. Preparation of feasibility study/report : ‡ Preparation of feasibility study/report : ‡ The stating point of a project analysis is the establishment of objectives to be attained. The next stage is the pre-selection stage ± to decide whether to go in for an in-depth study or not. 01/01/2010 130 .3.

and  the business will meet the goals of the founders.  the business will withstand the risks it will encounter.3. 01/01/2010 131 .  the business will remain viable in the long-term. Preparation of feasibility study/report : ‡ A feasibility study provides an Investigating function that helps answer ³Should we proceed with the proposed project idea? Is it a viable business venture?´ ‡ A feasible business venture is one where  the business will generate adequate cash flow and profits.

‡ To narrow down business alternatives. ‡ To enhance the probability of success by addressing and mitigating factors early on that could affect the project. ‡ To give focus to the project and outline alternatives. Preparation of feasibility study/report : Why a Feasibility Study? ‡ To provide a thorough examination of all issues and assessment of probability of business success. ‡ To unearth new opportunities through the investigative process. 01/01/2010 132 . ‡ To identify reasons NOT to proceed.3.

‡ To help to increase investment in the company. ‡ To provide documentation that the business venture was thoroughly investigated. ‡ To help in securing funding from lending institutions and other monetary sources.3. Data required for a feasibility study can come from primary or secondary sources. 01/01/2010 133 . Preparation of feasibility study/report : ‡ To provide quality information for decision making. ‡ Primary data can include formal interviews and surveys.

government agency reports (CSO) A feasibility study of an idea is conducted at five levels 01/01/2010 134 .3. Preparation of feasibility study/report : ‡ Collection of primary data can be expensive and time consuming ‡ Secondary data can include industry and trade publications. statistics of industry associations.

3. Level of risk:  Financial statements: total project cost. production cost.: income statements. initial capital requirements. cash flows and balance sheets. selling and admn. 01/01/2010 135 .  Financial projections for future time periods. credit period for purchases and expenses.  Supporting schedules for the financial projections. Expenses and financial expenses. BEP. stating the assumptions made regarding the collection period of sales. cash flows relative to the project schedule. Preparation of feasibility study/report : Financial Analysis : Profitability .

Equipment & Machinery. Process chosen. Technological Analysis : Scale of operation. break-even volume and price analysis. Preparation of feasibility study/report :  Financial analysis showing returns on investments.  Description of the product including specification relating to its physical.3. mechanical and chemical properties and uses of the product.  Sensitivity analysis /Risk analysis to identify items which have a substantial impact on profitability. 01/01/2010 136 . returns on equity .

including the expected volume for a given period on the basis of start-up and technical factors of the selected process. showing detailed flow charts and presenting alternative processes which may have been considered and the justification for the adoption  Determination of the plant size. Preparation of feasibility study/report :  Description of the selected manufacturing process.3. and production schedule. 01/01/2010 137 .

a comparative analysis of different sites. comparative analysis of alternatives in terms of cost. delivery dates. reliability performance and spare parts availability. including specifications. its origin. Preparation of feasibility study/report :  Selection of machinery. equipment to be purchased. terms of payment.3.  Identification of plant¶s location and an assessment of its desirability in terms of distance from raw material sources and markets. equipment. indicating the advantages and disadvantages of each. quotations from suppliers. 01/01/2010 138 .

location of sources of supply and continuity of supply. 01/01/2010 139 . terms of payment. including a detailed break-down of direct and indirect labour requirements.  Availability of the raw materials and utilities including a description of physical and chemical properties. current and prospective costs. and the supervision required for the manufacture of the product. Preparation of feasibility study/report :  Design of the plant layout and an estimate of the cost of the proposed buildings and land improvements. quantities needed.3.  Estimate of labour requirements.

Impact on society.  Contribution to the national economy: raising of aggregate consumption. Impact on saving & investment.  And an estimate of the production cost of the product. and the necessary clearance from proper authorities. Preparation of feasibility study/report :  Determination of the type and quantity of waste to be disposed of together with a description of the waste disposal method. 01/01/2010 140 .3. its costs. etc« Economical Analysis : From the point of view of the Society. redistribution of income.

01/01/2010 141 . channels of distribution. Preparation of feasibility study/report : Market Analysis : Aggregate demand.3. value of consumption and identification of the major consumers of the product. Market share.  The market analysis should cover the following areas:  A brief market description including the market area. and general trade practices.  An analysis of past and present demand. modes of transportation and costs. determination of quantity.

noise heat and vibrations while manufacturing of the product and disposing of the wastes/effluents. Cost to prevent the damage:  Study of different types of potential environmental pollution: gaseous emissions. such as selling prices. quality and marketing practices of competitors. 01/01/2010 142 . Preparation of feasibility study/report :  An analysis of past and present supply. broken down as source ± whether imported or domesticas well as information to assist in determining the competitive position of the product. Ecological Analysis : Effect on environment damage. (projections for the future also are required for the above factors).3.

Preparation of feasibility study/report :  Cost of restoration in the unfortunate event of damages (eg.3. Union Carbide«) 01/01/2010 143 .

D easi ili t tu d y f A ia g r a m m a ti c In i t i a l c re e n in g e p r e s e n ta tio n Is t e id e a rim a r m is in g ? a c ie e n e ra ti n id e a s I I A la n easi A n a l s is i l it es e rm in a te nduct ar et A n a l s is n d u c t e c h n ic a l A n a l s is A A nduct nduct in a n c ia l A n a l s is c o n o m ic a n d c o lo g ic a l A n a l s i s I A Is t h e ro je c t o rth w h ile ? o e rm in a te A es re p a re u n d in g ro p o s a l 01/01/2010 I 144 .

7 or 10 or any desired scale may be used). How to do it? Identify the factors relevant for the project rating. 01/01/2010 145 . Rate the project proposals on various factors. ( a 5.3. using a rating table. Assign weights to these factors depending upon their relative importance and criticality. Project Rating Index: Project Rating Index: The preliminary evaluation results of various projects in view may be translated into a Project Rating Index.

multiply the factor weight with the assigned rating and note the score.3. Project Rating Index: For each factor. Select the best of the projects whose ratings exceed the predetermined minimum rating. 01/01/2010 146 . Add all the factor scores to arrive at the overall Project Rating Index. Compare the Project Indices of the various short-listed projects with the pre-determined desired minimum Rating.

Project Rating Index: ‡ Refer to text books to see the numerical example of project ratings. .3.

‡ The aim of project formulation is to derive maximum benefits from minimum expenses in a short span of time. Project formulation. ‡ Project Formulation techniques help in making the final choice of a project.4. 01/01/2010 148 . ‡ Project Formulation (PF) is defined as taking a first look carefully and critically at a project idea by an entrepreneur to build up an all round beneficial project after carefully weighing its various components. ‡ Project formulation is the presentation of the Project idea which makes it easy to compare with the other project ideas.

‡ And therefore the objective(s) should be defined as precisely as possible. Project formulation. ‡ Steps in Project Formulation: Recall what we have already seen earlier: ‡ A project comprises of a series of activities for achieving a predetermined objective or a set of objectives. ‡ A general objective merely states in broad terms the achievements expected whereas an operational objective specifically mentions the results expected from the implementation of the 01/01/2010 149 project. . ‡ Objectives may be General or may be Operational.4.

Economic Viability. Legal Aspects) ‡ (If feasible: proceed to the next step. ‡ The seven distinct sequential stages in Project Formulation are: ‡ 1. ‡ The next stage is about the location and size of the project. If unable to decide for want of sufficient data: Collect more data).-(Technical Feasibility. Commercial Feasibility.4. Financial Feasibility. Project formulation.Feasibility Analysis: At this stage. If not feasible: drop the project idea. Organisational Aspects. the project idea is examined to decide whether to go in for a detailed investment proposal or not. 01/01/2010 150 .

‡ 2. DThe Techno-Economic analysis gives the project a unique individuality and sets the stage for detailed design development. ‡ 3.4.Techno-Economic Analysis: Estimation of the project demand potential and choice of optimal technology are made. D A detailed work plan of the project is prepared with time allocation for each activity and presented in a network drawing. 01/01/2010 151 .Project Design and Network analysis : This step defines the individual activities which constitute the project and their inter-relationship with each other. Project formulation.

4. DThe details of the inputs required at each stage should be prepared to arrive at the total requirements of the inputs for the project-both quantitatively as well as qualitatively.Input Analysis : This step assesses the input requirements during the construction as well as during the operation of the project. ‡ 4. which are essential to develop the financial and costbenefit profile of the project. 01/01/2010 152 . Project formulation DProject design is a critical element of the project and paves the way for a detailed identification and qualification of the project inputs.

‡ 5. DThis will help in arriving at the project cost which in turn will help a proper financial and costbenefit analysis.Financial Analysis: This stage involves estimating the project costs.4. 01/01/2010 153 . operating costs and funding requirements. DAn evaluation is made from the point of view of the availability of the required resources. Project formulation DBoth recurring and non-recurring requirements of inputs are taken into account. D It also helps comparing different projects on a common scale.

Social Cost Benefit Analysis: While Financial analysis will justify a project from the point of view of profitability. the Cost-Benefit Analysis will consider the project from the national viability point of view. DSince project investments are for long time horizons.4. it is absolutely necessary to exercise due care and foresight in developing project financial forecasts. Project formulation DThe tools used are DCF. CVP and Ratio analysis. 01/01/2010 154 . ‡ 6.

Project formulation DIn this analysis.4. DAll the results obtained from the previous stages are consolidated and various conclusions are arrived at to present a clear picture. but also the costs which all entities connected with the project have to bear and the benefits which will be enjoyed by all such entities. we not only consider the apparent direct costs and direct benefits of the project.Pre Investment Analysis: The project proposal gets a final shape at this stage. ‡ 7. DThis strategy is now an international norm for project formulation. 01/01/2010 155 .

‡ Evaluation of Risks:  Risk is the possibility of an outcome being different from the expected outcome.4. the project is presented in such a way that the project sponsors. 01/01/2010 156 .Evaluation of Risks: D At this stage. the implementers and the external consulting agencies are able to take a final decision as to whether to accept the project proposal or not. the possibility of adverse results flowing from the uncertainty involved in carrying out the activities.

01/01/2010 157 .  Both these factors should be thoroughly examined while conducting the risk analysis. Project is a function of uncertainty and damage.4.  The project manager should also provide for hazards and the appropriate safeguards to mitigate the risks.Evaluation of Risks:  Every activity of a project is exposed to some degree of risk.

always has a negative impact also. the size of the impact varies in terms of cost etc. or it wouldn't be a risk. . because then it would be a certainty. And it can't be exactly 0%.Evaluation of Risks: ‡ Based on the principle that a risk has two primary dimensions: ‡ Probability . (Note: It can't be exactly 100%.A risk is an event that "may" occur.A risk. The probability of it occurring can range anywhere from just above 0% to just below 100%. not a risk. However.4.) ‡ Impact . by its very nature.

.

you can cope with them and move on. ‡ High impact/High probability .Are of high importance but they're very unlikely to happen. ‡ High impact/Low probability .Risks in the top left corner are of moderate importance . and you can often ignore them. .Risks in the bottom left corner are low level.4.Evaluation of Risks: ‡ The chart has these characteristics: ‡ Low impact/Low probability . However.if these things happen.These are your top priorities. For these. ‡ Low impact/High probability . you should try to reduce the likelihood that they'll occur. however you should have contingency plans in place. and are risks that you must pay close attention to.

4.  Failure of the feasibility of a design. are some of the sources. changes in technology etc.  Technology obsolescence before the project is ready to start commercial production .Evaluation of Risks:  Some of the risks that arise in a project are: 1.  Software modules running well in small scale fail when integrated with some other modules.Technical risks: These risks refer to the failure to meet a particular performance requirement.

Economic Risks: Increase in the rate of inflation.  No control of project manager over these risks and so extra provisions while preparing projections even at planning stage.Social risks: Changes in the needs and preferences of the target customers. 3. strikes. changes in the economic policies of the government.4.Evaluation of Risks: 2.  Labour unrest. and social movements against the project (Example: Population displaced due to acquiring of land for a new project). 01/01/2010 162 .

 (The project manager should analyse the policies of the ruling party as well as the main opposition party) 01/01/2010 163 .Political risks: Nationalisation or privatization of an industry.Evaluation of Risks: 4. Political instability.4.

breakdown of machinery.Marketing risks: Failure of the developed product or service in the market due to changes in the market demand.Production risks: Shortage of necessary RM. 6. rise in installation and maintenance costs. errors in forecasting the demand at the planning stage«  (The Project manager should change the strategy) 01/01/2010 164 .  (These can be generally forecast at periodic intervals and hence safeguards can be built into the plan).Evaluation of Risks: 5.4.

01/01/2010 165 .Evaluation of Risks: 7. increase in interest rates. inter-group politics and rivalry among employees.) 8. mistakes in accounting procedures.  (Project manager has to constantly assess the project on these parameters so as to take corrective actions.Human risks: Sudden demise or resignation of key employees.Financial risks: Bad debts.4. non availability of competent employees.

4.Evaluation of Risks:  (Project manager should evolve suitable HR policies and implement them and also take group insurance schemes to reduce the sufferings of the families of the deceased employees) 01/01/2010 166 .

When the investment amount goes up. The timing and use of the tools depends on the µrisk tolerance¶ level of the project manager. Project managers may be µrisk averse¶ or µrisk neutrals¶ or µrisk seekers¶.Risk Management Risks can never be avoided completely. the utility-the satisfaction-. 01/01/2010 167 .4.that the project manager gets²of the risk averse project manager increases at a decreasing rate. Appropriate tools have to be used effectively to mitigate the risks.

assessed. and provided for.4. 01/01/2010 168 . utility increases at an increasing rate as the investment at stake goes up.Risk Management For a risk seeking project manager.´  The project manager has to be proactive rather than reactive while dealing with risks.  The PMBOK defines risk management as ³the formal process by which risk factors are systematically identified. The risk neutral project manager¶s utility lies in between the other two.

risk and uncertainty: o Project managers have to take many decisions under conditions of certainty. Certainty.Risk Management  The proactive project manager anticipates the risks and is ready with contingency plans whereas the reactive project manager waits for the risk to become visible as a problem and then starts thinking of solving the problem. o Decision making is easy in conditions of certainty.4. risk and uncertainty. 01/01/2010 169 .

o Decision making under certainty: o The project manager is fully aware of all the states of nature (the future events that are not in the control of the project manager) available and the expected payoffs for each state of the nature.4. o The project manager can construct a payoff matrix for all the states of nature and select the best possible strategy.Risk Management o The process becomes increasingly difficult as the condition changes from certainty to risk and to uncertainty as the expected potential damage to the project increases. 01/01/2010 170 .

o Homework: Prepare a sample pay off matrix for decision making under certainty. (See Chapter18 of IC). 01/01/2010 171 . probability distributions). states of nature) that can be described within established confidence limits (i.4. o Then all the possible outcomes for each action. under each state of nature are recorded to complete the payoff matrix.e.Risk Management o First the project manager formulates the strategy for each of state of nature. o Decision making under risk: PMBOK: ³Risk is the totality effect of outcomes (i.e.

01/01/2010 172 . the project manager can assign probability of occurrence to each state of nature with which he can also calculate the expected value for each of the strategies and finally select the best strategy earning higher returns.4. Homework: Construct a sample payoff matrix for decision making under risk. o The expected value of a strategy is the sum of the products of the probability of a state of nature and the respective payoff value of a strategy.Risk Management o Under conditions of risk.

Risk Management o Decision making under uncertainty: In this case the project manager does not know the probability of occurrence of each state of nature.4. ‡ Maximin criterion (Wald criterion): The project manager identifies the minimum payoff values of each strategy and adopts the strategy that has the highest payoff value. o He uses four types of criteria to select a strategy: ‡ Maximax criterion (Hurwicz criterion): The project manager chooses the strategy that is likely to earn him the highest returns. 01/01/2010 173 .

Risk Management ‡ Minimax regret criterion: The project manager attempts to minimise the maximum regret value (maximum opportunity loss). (The matrix is created from the matrix of decision making under risk) ‡ Criterion of realism. ‡ So the project manager considers the average value of all the payoffs for each strategy and selects the strategy that has the average highest payoff. 01/01/2010 174 .4. ‡ The regret value is arrived at by subtracting the pay off values in each state of nature from the largest payoff value of that state of nature. each state of nature has the same probability of occurrence. (Laplace criterion) : As per this criterion.

01/01/2010 175 .Risk Management  Decision Tree analysis: This analysis is used when a decision involves a series of several unrelated decisions. The project manager computes the Expected Monetary Value (EMV) of all strategies and chooses the strategy with the highest EMV.  Homework: Prepare a sample Decision Tree.4.

and risk symptoms. potential risk events.4.Risk Management ‡ Risk Management Methodology: Steps involved: ‡ Risk identification: Source of risks. Management Plan. PERT and CPM. Updates to risk. Risk mitigation and Risk acceptance. ‡ Risk response: Risk avoidance. 01/01/2010 176 . simulation. ‡ Risk control: Corrective actions. Probability distribution. ‡ Risk quantification: Decision trees. Risk transfer.

The Risk Management Process .

the project report is prepared before the investment in the project is undertaken.4. ‡ It gives a complete analysis of the inputs and outputs of the project. so as to take the decision whether to lend or not. 01/01/2010 178 . as it is the basis on which the whole project proceeds and the financiers also assess the project¶s viability on the basis of the project report. ‡ The project report records the merits and demerits in allocating resources to production of specific goods or services. Preparation of Project Report: ‡ Preparation of Project Report: ‡ Usually.

analysis of the market :  how big is the present market and potential for future growth?  what could be the market share in future assuming new entrants?.4. 01/01/2010 179 . ‡ The Scope of the project report covers the following aspects: ‡ Economic aspects: Economic justification for investment. Preparation of Project Report: ‡ Usually the promoter of the project gets the report prepared by consultants who are experienced in the line and that too in the areas of the product or service proposed in the project..

equipments and machinery needed. 01/01/2010 180 . Preparation of Project Report: ‡ Technical aspects: Details about the technology needed and where it is presently used successfully.4. DSCR«. debentures. sources of finance for the balance viz. term loans.. return on investment. their suppliers and report about their performance efficiency. D/E ratio. cash flows for the tenure of the loan sought. cost of capital . return on equity. breakup of promoter¶s contribution. ‡ Financial aspects: Total investment required. equity/preference equity from public.

other managers well conversant with Labour laws.  (Production Manager. Marketing/Sales Managers. HR manager.. Factory acts. its design. Preparation of Project Report: ‡ Production aspects: Description of the product selected.. which are the markets«. and the reasons for the selection. tax laws and other laws concerned with running such establishments) 01/01/2010 181 . whether can be exported and if so.4. Purchase manager. ‡ Managerial aspects: Qualifications and experience of the key management team in the line of the product or service.

prices. 01/01/2010 182 . Preparation of Project Report: ‡ The contents of a project report will consist of the following:  Objective and scope of the report. transportation).  Product characteristics.  RM ( requirement in quantity.4. sources of supply and their properties. export prospects.  Marketing channels (trading practices and marketing strategy). price structure and trends). production and anticipated demand.  Market position and trends (installed capacity.

. labour and their availability.  Land and building (land area. cost of labour. production schedule and technique).  Plant and machinery ( equipments.  Personnel (requirements of staff at various levels. building. Preparation of Project Report:  Manufacture (process. instruments. lab equipments. selection of process.4. machinery. construction schedule). electric load. water supply).) 01/01/2010 183 .

an enterprises starts a new project for production of a product or service.5.Selection of location and site of the project: ‡ Selection of location and site of the project: ‡ Location of the site and plant are critical to the operation of the set up in an interruption-free manner. an existing enterprise goes for an expansion of capacity or diversification of its product range and the existing location cannot accommodate additional work space. ‡ The need for a new location arises when: 1. ‡ An ideal site not only saves on costs but also enhances productivity and profits. 01/01/2010 184 . 2.

5.Selection of location and site of the project: 3. whereas wrong location leads to wastage in efforts and talents of the promoters. or lease of the land expires and the co. a necessity arises to shift the existing plant to another location due to various factors ± like depletion of raw materials in near by areas. 01/01/2010 185 . is unable to extend the lease etc. efficiently and with minimum cost. ‡ A good location enables the enterprise to function smoothly.

Selection of the region or general area.5. 2. Atwater and Smith. selection of the exact optimum plant site. 01/01/2010 186 . enterprise location involves three main steps which are: 1. ‡ Sometimes the choice of the location is not that of the promoters but that of the Government due to licensing regulations (example: Chemical Zone. Pharmaceutical Zone etc).Selection of location and site of the project: ‡ According to Bethel. Selection of a particular community or locality and 3.

(Example: Aluminium Industry) 01/01/2010 187 . schools/colleges.Selection of location and site of the project: ‡ Location is extremely important from another point of view also: availability of social infrastructure like. location near an airport/sea port would be preferred. recreation facilities etc. ‡ In the case of export oriented industries.5. reasonably good housing. ‡ Power hungry industries should avoid power deficit locations. if best talent is to be attracted and retained. hospitals.

even if the employees may not have any grievance against he unit.5. ‡ The factors affecting the location of an enterprise can be listed as follows: 01/01/2010 188 .Selection of location and site of the project: ‡ Nearness to a heavy industrialised area has its advantages in respect of infrastructure but has also a disadvantage in the form of spread of unionism.

‡Cheapness of land allows freedom for most economic design for building. Rural Area ‡Cost of land is less & scope of future expansion is more. ‡Easier to sell building later. ‡Lesser taxes & restriction. ‡Power & water easily available. ‡Healthy & pleasant atmosphere. ‡Good market for small mfrs. .Urban Area ‡Possible to find existing building to house factory.

‡Opportunity to exchange knowledge from nearby industries. Enterprise or local authority. market. banks. ‡Workers find easy to change ‡Less labour trouble & job & area has good labour labour is cheap. railways & education available. ‡Housing can be provided by pvt. . fire protection. ‡Transportation is easy & cheap. ‡Repairing facility available with existing industries. ‡Road or rail connection can be arranged easily.‡Housing.

U rb a n a re a ‡ C lim a te is n o t h e a lth y d u e to c o n g e s tio n . ‡ N o r e c r e a tio n a l fa c ilitie s . ‡ H ig h e r w a g e s o f la b o u r d u e to h ig h s ta n d a r d o f liv in g . ‡ E d u c a t i o n a l f a c i l i t ie s m a y n o t b e a v a ila b le . ‡ E n o u g h fa c ilitie s fo r e x p a n s io n m a y n o t b e a v a ila b le . ‡ M o r e p r o b le m s a b o u t la b o u r & e m p lo y e e r e la tio n s ‡ C o s t o f b u ild in g fa c to r y w ill b e h ig h . ‡ A r r a n g i n g e q u i p m e n t is n o t p o s s i b l e d u e t o l i m it e d a re a . . ‡ H ig h ta x e s . ‡ G o v e r n m e n t f a c i l i t ie s m a y n o t b e s u ffic ie n t. ‡ T r a n s p o r t & h o u s in g fa c ilitie s m a y n o t b e s a t is f a c t o r y . ‡ S k ille d w o r k e r s a r e n o t e a s ily a v a ila b le . ‡ C o s t o f l a n d is h i g h & s c o p e o f e x p a n s io n is le s s . R u ra l a re a ‡ S u f f ic i e n t p o w e r & w a t e r m a y n o t b e a v a ila b le .

Selection of Region Selection of Community/location Availability of RM Availability of labour Nearness to market Civic amenities for workers Availability of power and fuel Existence of complementary and competing industries Transport Banking/Finance and Research facilities Suitability of climate Availability of water and fire fighting facilities Government policy Local taxes and restrictions Competition among states Momentum of an early start Meteorological conditions and Communication facilities topography Cultural affinity and harmony Religious and social institutions Educational environment Historical factors Political stability 01/01/2010 192 .

Selection of site Optimum selection of site Soil. right and title of the land the alternative sites in aquestion. Potential for expansion Commercial services/Communication facilities Health of locality. good scenery Statutory considerations Flood and drought experience Attitude of local people State Assistance 01/01/2010 193 . size and topography Optimum site is selected on the basis Waste disposal of a comparative economic survey of Price of land.

fish-canning & salt pans near coast. in Jaipur.g. Sandal Wood products in Mysore.Selection of location and site of the project: ‡ Generally speaking.P. Export of Alphonso mangoes from Ratnagiri. Marble mfrg. if the value addition is low. Sugar factories in U.) ‡ --but if the value addition is high then the location may be chosen considering the other more important critical factors since transportation costs can be absorbed. (For e.5. then the location may be near the source of RM.: Textile and sugar mills in Maharashtra. 01/01/2010 194 .

to influence the location: They are: Positive measures and Negative measures. 01/01/2010 195 .Selection of location and site of the project: ‡ A recent survey found that most of the SMEs had their location near their residence and had ignored the economics of the location of the industry.5. ‡ There are two types of measures that may be adopted by the Govt. More than 50% of these SMEs had failed within five years. ‡ POSITIVE measures encourage growth by various inducements extended to the industrialists to setup their projects in certain specified areas. ‡ NEGATIVE measures impose restrictions on the location of projects in certain congested areas.

if the plant is to be located beyond 25 Kms. less resources will be available for investment in other regions. ‡ In cities with population of more than 1 million.5. ‡ If more resources are invested in one region.Selection of location and site of the project: ‡ Both sets of measures are necessary for the effective location policy. of periphery of the cities. there is no requirement of obtaining industrial approvals from central government. 01/01/2010 196 .

water etc. 01/01/2010 197 .): again these are of two types : weight losing and weight gaining.Selection of location and site of the project: ‡ Weber¶s Theory of Industrial Location: (Alfred Weber: was a professor at the University of Heidelberg from 1907 to 1933): ‡ Two types of materials used in an industry: ‡ Ubiquitous: available everywhere.like brick.5. clay. ‡ Localised materials (which are available only in certain localities ±like ores minerals etc.

Selection of location and site of the project: ‡ Weight losing materials lose considerable weight during the process of manufacture.like. coal. and require transport.for example. 01/01/2010 198 . ‡ Such industries should be located near the source of RM ‡ Weight gaining materials are those which become heavier than the raw materials after manufacture. water added to the raw material to make the final product. ‡ Such industries should be located near the market.5.

199 01/01/2010 . ‡ Auxiliary industries. ‡ The clustering and linkages allow individual firms to enjoy both internal and external economies. not just to lower costs but to serve the bigger populations.5.Selection of location and site of the project: ‡ Industries get redistributed in different localities due to the µdeglomerative¶ forces. ‡ µAgglomeration¶ is the phenomenon of spatial clustering. specialized machines or services used only occasionally by larger firms tend to be located in agglomeration areas. or a concentration of firms in a relatively small area.

lead to an offset of initial advantages and increase in Project cost ‡ Then the force of agglomeration may eventually be replaced by other forces which promote deglomeration. after reaching an optimal size. 200 01/01/2010 . ‡ However. local facilities may become over-taxed.Selection of location and site of the project: ‡ µDeglomeration¶ occurs when companies and services leave because of the diseconomies of industries¶ excessive concentration. ‡ Firms who can achieve economies by increasing their scale of industrial activities benefit from agglomeration.5.

01/01/2010 201 . ‡ The third assumption is raw materials are fixed at certain locations.5. ‡ His first assumption is known as the isotropic plain assumption. This means the model is operative in a single country with a uniform topography. climate. and the market is also a known fixed location. and the product is shipped to a single market. technology.Selection of location and site of the project: ‡ His theory has five assumptions. ‡ His second assumption is that only one finished product is considered at a time. economic system.

‡ Selection of the most Economic site: According to Kimball.Selection of location and site of the project: ‡ The fourth assumption is that labor is fixed geographically but is available in unlimited quantities at any production site selected. ³the most advantageous location is that at which the cost of gathering material and fabricating it plus the cost of distributing the finished product to the customer will be minimum´. 01/01/2010 202 . ‡ The final assumption is that transport costs are a direct function of weight of the item and the distance shipped.5.

) Cost of production and distribution: ( Materials cost. Overheadstaxes. insurance.Selection of Actual Site: Items of cost Cost per unit at the site Site A Site B Site C Fixed Capital (Land. depreciation) Total: 01/01/2010 203 .. Labour cost. equipment. building.

arrangement of machinery and equipment. 01/01/2010 204 . and provision of service facilities. ‡ Factory Layout Planning: ‡ Factory Design ± it is the plan for a particular type of building.5.Selection of location and site of the project: In order to arrive at the final decision for the most economic site. heating. a comparative statement as shown above has to be prepared for all the alternative sites. ventilation. lighting. etc. in the building.

‡ It must be flexible so that it may be easily adapted to technological change. such as the nature of materials to be handled««« 01/01/2010 205 . modernization.Selection of location and site of the project: ‡ It influences the operational costs. diversification and expansion with minimum cost and time. ‡ Factors to be considered ± ‡ Knowledge of what is involved in the activity concerned. boosts the morale of the workers and ensures maximum supervision.5.

‡ The sequence of operations ‡ Movement of materials from one stage to another should be minimum... assembly procedures.. inspection and quality control at various stages.. packing. their quality and quantity.«««..5. ‡ Plant layout ± is a floor plan for determining and arranging the desired machinery and equipment of a plant in one of the best place. etc.. 01/01/2010 206 . the process they have to be subjected to.Selection of location and site of the project: ‡ .

to permit the quickest flow of materials at the lowest cost and with the least amount of handling in processing the product from the receipt of the raw materials to the shipment of the finished products. the existing layout in the light of subsequent developments in the methods of production. 01/01/2010 207 . ‡ It not only covers the initial layout of machines and other facilities but encompasses improvement in.. or revision of.Selection of location and site of the project: ‡ ««.5.

CLIMATIC CONDITIONS HOUSE FOR LABOURERS WATER GAS ELECTRICITY WIRES MARKET/VENDORS WASTE DISPOSAL PLANT LOCALITY BANK REGION RAW MATERIAL SPORTS COMPETITORS SCHOOL GYMKHANA .

) Value of output 209 .MEASURE OF SIZE INPUT (a.) Number and capacity of 01/01/2010 plant OUTPUT (a.) Volume of output (b.) Power needed (f.) Net worth (b.) Size of assets (c.) Employment (d.) Raw materials required (e.

5.Selection of location and site of the project: Factors for evaluating Plant Layout: ‡ Production technology and Product-mix ‡ Efficient. economic and uninterrupted flow of human and materials resources ‡ Proper space for maintenance ‡ Future expansion / diversification of the project ‡ Safety precautions particularly when explosive or bulky material is required to be handled 01/01/2010 210 .

5.Selection of location and site of the project: ‡ Proper lighting and ventilation ‡ Proper layout of utilities and services and provisions for effluent disposal ‡ Effective supervision of work ‡ Proper storage and stacking space Importance of Layout: ‡ Effective use of available area ‡ Minimization of production delays ‡ Improved quality control ‡ Minimum equipment investment ‡ Avoidance of bottlenecks 01/01/2010 211 .

5.Selection of location and site of the project: ‡ ‡ ‡ ‡ ‡ ‡ ‡ Better production control and supervision Improved utilization of labour Improved employee morale Maximization of production Avoidance of unnecessary and costly changes Increased revenues and profits Success of the enterprise 01/01/2010 212 .

5. process of manufacture) ‡ Lighting and ventilation 01/01/2010 213 .Selection of location and site of the project: Factors affecting Factory Layout: ‡ Nature of product (light or heavy products) ‡ Volume of production (high or low) ‡ Materials handling ‡ Type of equipment (specifications of machinery and equipment±general / specialized machines) ‡ Factory building ‡ System of manufacture (i.e.

to be worked in the right manner for completing the manufacturing process in the SHORTEST possible time. stores. 01/01/2010 214 .Selection of location and site of the project: ‡ Service facilities (canteen. toilets. etc) Materials Handling: ‡ ³The right equipment. fire escapes. at the right position. intermediate stores and work places should be interlinked so that the production may flow uninterruptedly. drinking water.5. ‡ This includes that the layout should be such that the new materials. first aid.

but only to the cost. Advantages of Materials Handling: ‡ Reduced labour cost ‡ Increased capacity of existing building ‡ Better machine utilization 01/01/2010 215 . ‡ Handling adds nothing to the value of the product.Selection of location and site of the project: ‡ A good layout not only improves material handling operations but also increases the production and productivity per employee.5.

Selection of location and site of the project: ‡ ‡ ‡ ‡ ‡ ‡ Less capital tied-up in work-in-progress Easier stock control Less fatigue for operations More efficient production control Better inspection and control of quality Improved safety 01/01/2010 216 .5.

5. whether established or contemplated in the best place.Selection of location and site of the project: In short a Good Plant layout can be defined as: ‡ ³a floor plan for determining and arranging the desired machinery and equipments of plant. permit the quickest flow of material at the lowest cost and with the least amount of handling in processing the product from the receipt of the raw material to the shipment of finished goods´ .

¶S· Type R Combination of ¶T· and ¶U· Type FG R FG ¶O· Type or Circular Flow R FG .

Third Floor Second Floor First Floor FG R FG Ground Floor R .

6.4/7 19 ± 5.6/7 23 ± 4.1/7 126 -14 108 .7/7 36 ± 4/7 121 -13 93 .3/7 23 ± 5. Legal aspects of Project management As per World Economic Forum¶s Global Competitiveness Review 2010-11: 139 countries compared. of days.1/7 51 ± 4.to start a business 01/01/2010 Rank-China 53 ± 4/7 63 ± 4.8/7 29 ± 4.4/7 26 ± 4.30 .4/7 30 ± 5.Policies of Central and State Governments towards location.2/7 50 ± 4. Parameter Rank -India Quality of Education System Quality of Management Schools Availability of specialised research and training services Intensity of local competition Extent of market dominance Extent and effect of taxation Number pf procedures required to start a business Time required-no.37 220 39 ± 4.

2/7 Prevalence of foreign ownership 81 ± 4.3/7 51 ± 3/7 .6/7 Business impact of rules on FDI Burden of customs procedures Pay and productivity Reliance on Professional Management Brain Drain Availability of Financial Services Financing through local Equity Market Ease of access to loans 46 ± 5/7 18 ± 5.Parameter Rank India Rank China 69 -4.7/7 49 ± 4.3/7 45 ± 5.4/7 81 ± 4/7 46 ± 4.8/7 39 ± 3.7/7 50 ± 4.5/7 61 ± 4/7 15 ± 4.3/7 37 ± 4.1/7 71 ± 4.4/7 Prevalence of Trade barriers 96 ± 4.6/7 103 -4.7/7 52 ± 3.7/7 34 ± 4.6/7 10 ± 4.

1/7 Soundness of Banks 25 ± 5.9 54 ± 4.4/7 Competitive advantage .3/7 Availability of latest technologies 41 ± 5.6/7 Nature of (International) 61 ± 3.4/7 2 ± 6.2/7 4 Restriction on Capital Flows 75 ± 4.4/7 123 ± 3.6/7 1 ± 7/7 2 88 ± 27.8/7 Regulation of Securities Exchanges 15 ± 5.7/7 48 ± 3.6/7 Domestic Market Size Index 4 ± 6.1/7 Foreign Market Size Index GDP (PPP) 4 ± 6.6 Business ± Local Supplier Quality 60 ± 4.3/7 60 ± 5.4/7 94 ± 4.3/7 Exports as a percentage of GDP 117 ± 20.3/7 61 ± 4.7/7 Venture Capital Availability 31 ± 3.Parameter Rank India Rank China 27 ± 3.

7/7 Institutions Availability of Scientists and 15 ± 5. See the website of World Economic Forum for the full text of the report. Only a few have been listed above so as to give a rough idea of where we stand which in turn will give some ideas as to the areas in which projects can be thought of.3/7 35 ± 4.9/7 39 ± 4.6/7 51 ± 1.Parameter Rank India Rank China 55 ± 3. .6 The report contains ranking of 139 countries on 12 broad parameters (listed in the next slide) (and sub-parameters under them).2 Production Process sophistication 43 ± 4.2/7 Engineers Utility Patents per million population 59 ± 0.3/7 Quality of Scientific Research 30 ± 4.

.

This table is from the last year¶s report .

At present: ‡ Sourced from: The Secretariat of Industrial Assistance (SIA). of Industrial Policy and Promotion-DIPP. 226 01/01/2010 .: ‡ Brand India: R & D base for 100 of the 500 Fortune Companies.6. ‡ Strong Base for manufacturing: Most MNCs like Toyota. Ford. GM etc source components from India and also manufacture in India. ‡ Hero Honda is the world¶s largest motorcycle manufacturer.India . ‡ Among the only three Asian countries with super computing competence. (Dept. Volvo.. Ministry of Commerce and Industry). Hyundai¶s car manufacturing facility in India is the global base for exports of its small cars.

At present: ‡ Abundant availability of untapped natural resources.India . unskilled. semi skilled and skilled labour availability at competitive wages. and agricultural self-sufficiency. rich mineral base. 01/01/2010 227 .6. spanning almost all areas of manufacturing activities. ‡ Large and expanding consumer market with increasing purchasing power for branded consumer products. ‡ Large manufacturing capability..

6. 01/01/2010 228 . of India by liberalising and globalising the Indian economy.. At present: ‡ All the above are statements of facts and made possible by the proactive steps taken by the Govt.India .

Formulation of FDI policy 4. Trademark.6. Monitoring industrial growth ± infrastructure.. Functions: 1. environment etc 2. technology. Patents etc 6. Policies related to IPR. Promotion of Non Resident Investment 5. DIPP: Established in 1995 -.Industrial Policy. Approval of Foreign Technology collaborations and forming policies 3.Responsible for formulation and administration of industrial policy. Development of Industrial corridors as well as backward states .

of India: Objectives: ‡ to maintain a sustained growth in productivity. ‡ to enhance gainful employment.Industrial Policy. Main features of the Industrial Policy of Govt.. Policy focus is on : ‡ Deregulating Indian industry. ‡ Allowing the industry freedom and flexibility in responding to market forces and ‡ Providing a policy regime that facilitates and fosters growth of Indian industry. 01/01/2010 230 .6. ‡ to attain international competitiveness and ‡ to transform India into a major partner and player in the global arena. ‡ to achieve optimal utilisation of human resources.

At present. Isocyanates and Di-Isocyanates of Hydrocarbon and derivatives) 01/01/2010 231 . Policy measures: ‡ Some of the important policy measures announced and procedural simplifications undertaken to pursue the above objectives are as under: ‡ i) Liberalisation of Industrial Licensing Policy ‡ The list of items requiring compulsory licensing is reviewed on an ongoing basis. 4.Explosives.Industrial Policy.6..Electronic Aerospace and Defence equipment.Alcoholics drinks. only five industries are under compulsory licensing mainly on account of environmental. 3.Hazardous Chemicals such as Hydrocyanic Acid. Phosgene. 2. safety and strategic considerations. ‡ (1.Cigarettes and tobacco products. 5.

2.Atomic Energy. When the proposed location attracts locational restriction Similarly. Industries retained under compulsory licensing 2.. ‡ (1. At present.Arms & Ammunition and the allied items of defence equipments. industrial license is required only for the following: 1. there are only three industries reserved for the public sector.6.Industrial Policy. defence air-crafts and warships. Manufacture of items reserved for small scale sector by larger units 3. 3.Railway transport) ‡ ii) Introduction of Industrial Entrepreneurs¶ Memorandum (IEM) 01/01/2010 232 .

.7.1998.Industrial Policy. ‡ Industries not requiring compulsory licensing are to file an Industrial Entrepreneurs¶ Memorandum (IEM) to the Secretariat for Industrial Assistance (SIA). Amendments are also allowed to IEM proposals filed after 1. No industrial approval is required for such exempted industries. ‡ iii) Liberalisation of the Locational Policy ‡ A significantly amended locational policy in tune with the liberalised licensing policy is in place: ‡ No industrial approval is required from the Government for locations not falling within 25 kms of the periphery of cities having a population of more than one million except for those industries where industrial licensing is compulsory.6. 01/01/2010 233 .

Industrial Policy. 01/01/2010 234 . ‡ Non-polluting industries such as electronics..6 6.7.91. ‡ Permission to other industries is granted in such locations only if they are located in an industrial area so designated prior to 25. Zoning and land use regulations as well as environmental legislations have to be followed. computer software and printing can be located within 25 kms. of the periphery of cities with more than one million population.

6. ‡ iv) Policy for Small Scale Industries ‡ Reservation of items of manufacture exclusively for the small scale sector forms an important focus of the industrial policy as a measure of protecting this sector.Industrial Policy. industrial undertakings with an investment upto rupees one crore are within the small scale and ancillary sector. 01/01/2010 235 . Since 24th December 1999..

25 lakhs. is prescribed for qualifying as a small scale unit. The investment limit for tiny units is Rs.Industrial Policy. ‡ 749 items are reserved for manufacture in the small scale sector. 01/01/2010 236 .6. ‡ A differential investment limit has been adopted since 9th October 2001 for 41 reserved items where the investment limit upto rupees five crs.. All undertakings other than the small scale industrial undertakings engaged in the manufacture of items reserved for manufacture in the small scale sector are required to obtain an industrial license and undertake an export obligation of 50% of the annual production.

the Export Processing Zone (EPZ) or the Special Economic Zone Schemes (SEZs).Industrial Policy. not applicable to those undertakings operating under 100% Export Oriented Undertakings Scheme.6. ‡ V) Non-Resident Indians Scheme ‡ The general policy and facilities for Foreign Direct Investment as available to foreign investors/company are fully applicable to NRIs as well.. ‡ This condition of licensing is. however. 01/01/2010 237 .

01/01/2010 238 . Apart from this.6. NRI/OCBs are also allowed to invest on repatriation/non-repatriation under the portfolio investment scheme. ‡ In addition. ‡ NRI/OCBs are also allowed to invest upto 100% equity on non-repatriation basis in all activities except for a small negative list. ‡ These inter-alia includes (i) NRI/OCB investment in the real estate and housing sectors upto 100% and (ii) NRI/OCB investment in domestic airlines sector upto 100%. Government has extended some concessions specially for NRIs and overseas corporate bodies having more than 60% stake by the NRIs..Industrial Policy.

. Electronic Hardware Technology Park (EHTP) and Software Technology Park (STP) are in operation.6. 01/01/2010 239 .Industrial Policy. the inputs are allowed to be procured free of duties. two schemes viz. ‡ Under EHTP/STP scheme. ‡ vi) Electronic Hardware Technology Park (EHTP)/Software Technology Park (STP) scheme ‡ For building up strong electronics industry and with a view to enhancing export.

. The IMSC is serviced by the SIA. are considered by the Inter-Ministerial Standing Committee (IMSC) Chaired by Secretary (Information Technology). ‡ The Directors of STPs have powers to approve fresh STP/EHTP proposals and also grant postapproval amendment in respect of EHTP/STP projects as have been given to the Development Commissioners of Export Processing Zones in the case of Export Oriented Units. ‡ All other applications for setting up projects under these schemes. 01/01/2010 240 .6.Industrial Policy.

01/01/2010 241 . ‡ The Department has put in place a liberal and transparent foreign investment regime where most activities are opened to foreign investment on automatic route without any limit on the extent of foreign ownership.6. ‡ vii) Policy for Foreign Direct Investment (FDI) ‡ Promotion of foreign direct investment forms an integral part of India¶s economic policies.Industrial Policy.. ‡ The role of foreign direct investment in accelerating economic growth is by way of infusion of capital. technology and modern management practices.

‡ defence industry (upto 26%).6. inter-alia. include: ‡ opening up of sectors such as Insurance (upto 26%).. 01/01/2010 242 . Some of the recent initiatives taken to further liberalise the FDI regime.Industrial Policy. ‡ tea plantation (upto 100% subject to divestment of 26% within five years of FDI). ‡ development of integrated townships (upto 100%).

.Industrial Policy. ‡ Enhancement of FDI limits in private sector banking. 01/01/2010 243 . ‡ electronic mail and voice mail to 100% foreign investment.6. ‡ opening up B2B e-commerce. Internet Service Providers (ISPs) without Gateways. ‡ allowing FDI up to 100% under the automatic route for most manufacturing activities in SEZs.

Activities/items that require an industrial license 3.FDI Restrictions FDI up to 100% is allowed under the automatic route in all activities/sectors except the following: 1. Sectors prohibited for FDI 2. 1997 is attracted . Proposals in which the foreign collaborator has an existing financial/technical collaboration in India in the same field 4. Proposals for acquisitions of shares in an existing Indian company in financial service sector and where SEBI (substantial acquisition of shares and takeovers) regulations.

FDI Restrictions«. All proposals falling outside notified sectoral policy/CAPS under sectors in which FDI is not permitted 6. The sectors that are not in the automatic route. investment requires prior approval of the Central Government. The approval in granted by Foreign Investment Promotion Board (FIPB). 5. .

Pisiculture and Cultivation of Vegetables. Horticulture. Mushrooms etc. Development of Seeds..Prohibited Industries for FDI The extant policy does not permit FDI in the following cases: Gambling and betting Lottery Business Atomic Energy Retail Trading Agricultural or plantation activities of Agriculture (excluding Floriculture. Animal Husbandry. under controlled conditions and services related to agro and allied sectors) and Plantations (other than Tea Plantations) .

‡ The Department has also strengthened investment facilitation measures through Foreign Investment Implementation Authority (FIIA).Industrial Policy. ‡ Trade Policy Reforms: Most items freely importable. quantitative restrictions lifted. 01/01/2010 247 .6..

BPO and food processing. Rationalisation of Tax Structure: Reduction in peak customs tariff from 300% in 1991 to 25% in 2004. electronics.6. Competition law enhanced and Competition Commission constituted. 01/01/2010 248 . ‡ Monetary Policy and Financial Sector Reforms: Securitisation Act for better security for creditors. software.. ‡ Independent Regulators SEBI and IRDA in place. ‡ Special investment and tax incentives for exports in certain sectors such as power.Industrial Policy.

location. which are specifically aimed at enhancing the flow of FDI. 01/01/2010 249 . production.. Digital database library of patents.6. ‡ Conducive foreign investment environment that provides freedom of entry. dividends etc.Industrial Policy. repatriation of capital. investment. trademarks and design records. ‡ IPR initiatives taken : IPR laws are TRIPS compliant. choice of technology. IPR appellate Tribunal functional from 2003.

the role of this Department has moved to facilitation of technology and investment flows and promotion of industrial development in the liberalized environment.6. there has been a consistent expansion in the role and functions of this Department. initiated in July 1991.DIPP: Annual Report 2007 ± 08: ‡ With the progressive liberalization of the Indian economy. ‡ From regulation and administration of the industrial sector. 01/01/2010 250 .

6. in order to make the Indian industry internationally competitive. infrastructure.DIPP: Annual Report 2007 ± 08« ‡ The role and functions of the Department of Industrial Policy and Promotion (DIPP) primarily include: ‡ Formulation and implementation of industrial policy and strategies for industrial development in conformity with the developmental needs and national objectives. ‡ Monitoring and stimulation of industrial growth in general. . technology transfer/ collaborations on all industrial and technical matters. and performance of industries specifically assigned to it in particular and guidance in the creation of an enabling environment.

. ‡ Association. for investment related issues in Bilateral/regional economic Cooperation Agreements.DIPP: Annual Report 2007 ± 08« ‡ Approval of foreign technology collaborations at enterprise level and formulation of policy parameters for the same. ‡ Formulation of Foreign Direct Investment (FDI) Policy and amendments thereto as well as promotion and facilitation of direct foreign and non-resident investment in industrial and service projects.6. as nodal department. for enhancing productivity. with reference to international benchmarking.

1951.DIPP: Annual Report 2007 ± 08«: ‡ Formulation of policies relating to Intellectual Property Rights in the fields of Patents. Trademarks. hilly and inaccessible areas of the Special category States of «« 01/01/2010 253 . ‡ Promotion of Industrial development of industrially backward and remote. ‡ Administration of Industries (Development & Regulation) Act.6. Industrial Designs and Geographical Indications of Goods and administration of regulations and rules made thereunder.

‡ Compilation of data/statistics on Foreign Direct Investment & analysis thereof . 01/01/2010 254 . Jammu & Kashmir. quality and technical cooperation. Himachal Pradesh and Uttarakhand through special incentive packages. and ‡ Compilation of monthly industrial production statistics for use in the construction of Index of Industrial Production (IIP).DIPP: Annual Report 2007 ± 08«: ‡ ««North Eastern Region including Sikkim). ‡ Promotion of international cooperation through productivity.6.

development and planning aspects of specific industries allocated to them. keeping in view the national priorities and socioeconomic objectives. ‡ While individual Administrative Ministries look after the production. 01/01/2010 255 . this Department is responsible for the overall Industrial Policy. distribution.DIPP: Annual Report 2007 ± 08: ‡ The Department is responsible for formulation and implementation of promotional and developmental measures for growth of the industrial sector.6.

DIPP: Annual Report 2007 ± 08. 01/01/2010 256 .: ‡ This Department is the nodal organization for the promotion of productivity in the industrial sector. by sourcing experts to advise on productivity related projects and by deputing officials from the private and public sector to programmes conducted by the APO in industry. ‡ It undertakes programmes of technical cooperation with the Asian Productivity Organization (APO).6. Tokyo. agriculture and service related sectors..

6. which has been certified by international accreditation bodies. ‡ Schemes For Industrial and Infrastructure Development: 01/01/2010 257 .DIPP: Annual Report 2007 ± 08«: ‡ It also promotes the adoption of quality standards relating to the ISO 9000/14000 series through the accreditation services provided by National Boards for Certifying Bodies and Auditors and Trainers under the Quality Council of India.

.: ‡ This Department administers the Industrial Infrastructure Upgradation Scheme (IIUS) for enhancing the competitiveness of the domestic industry by providing quality infrastructure through public-private partnership in selected functional clusters. inter-alia.6. the following: 01/01/2010 258 . is provided under the Scheme ‡ FDI Promotion Initiatives : Several steps have been initiated to facilitate increased FDI inflows which include. Central assistance up to 75% of the project cost subject to a maximum of Rs. 50 crs.DIPP: Annual Report 2007 ± 08.

DIPP: Annual Report 2007 ± 08: ‡ (a) On the policy front.6. 01/01/2010 259 . the policy is being further progressively rationalised. ‡ (b) On the investment promotion front. ‡ (c) The Foreign Investment Implementation Authority (FIIA) has been activated towards speedy resolution of investment related problems. the Department organises Destination India events in association with CII and FICCI. while our FDI policy is already very liberal.

Indo-EU. Such interactions have been held in bilateral/ regional/ international meets such as Indo.ASEAN. etc.6. Meetings with individual investors were also held on a regular basis.DIPP: Annual Report 2007 ± 08: ‡ (d) National Manufacturing Competitiveness Council has been set up to provide a continuing forum for policy dialogue to energise and sustain the growth of manufacturing industries. ‡ (e) The Department has regular interaction with foreign investors. Indo-Japan. 01/01/2010 260 .

DIPP: Annual Report 2007 ± 08: ‡ (f) The Department website ( www. Äa large English speaking population Äand an independent judiciary etc. technical and managerial manpower.nic. Äabundant natural resources. Ä world-class scientific.in ) has been made both comprehensive and informative with online chat facility. About 4500 investment related queries were replied during the year.dipp. Ä cost effective and highly skilled labour. 01/01/2010 261 .6. ‡ Investment Climate : The advantages of India as an investment destination rest on strong fundamentals which include: ‡ Ä a large and growing market.

01/01/2010 262 .DIPP: Annual Report 2007 ± 08: ‡ This is now recognised by a number of global investors who have either already established a base in India or are in the process of doing so. such as further simplification of rules and regulations and improvement in infrastructure are expected to provide necessary impetus to increase FDI inflows in future. ‡ Ongoing initiatives.6. .

11/10/2007): 01/01/2010 263 .6. ‡ Rehabilitation and resettlement policy and associated legislative measures relating to land acquisition : (Press Information Bureau .DIPP: Annual Report 2007 ± 08: ‡ All the State Governments offer some or the other incentives to Industrialists to induce them to invest in their states ± so that the economy of the state can grow at the needed pace. Government of India.

and others whose livelihood depends on the land involved. protecting the interests of the land owners.6. the landless. and others. artisans. 01/01/2010 264 . such as the tenants. the agricultural and non-agricultural labourers. at the same time.Rehabilitation and Resettlement Policy: ‡ The new Policy and the associated legislative measures aim at striking a balance between the need for land for developmental activities and.

6.Rehabilitation and Resettlement Policy: ‡ The benefits under the new Policy shall be available to all affected persons and families whose land. ‡ The Policy will be applicable to all these cases irrespective of the number of people involved. etc. 01/01/2010 265 . property or livelihood is adversely affected by land acquisition or by involuntary displacement of a permanent nature due to any other reason. such as natural calamities.

land-for-land. ‡ preference for employment in the project to at least one person from each nuclear family within the definition of the µaffected family¶.6.Rehabilitation and Resettlement Policy: ‡ The benefits to be offered under the new Policy to the affected families include. subject to the availability of vacancies and suitability of the affected person. to the extent Government land would be available in the resettlement areas. 01/01/2010 266 .

6. ‡ preference to groups of cooperatives of the affected persons in the allotment of contracts and other economic opportunities in or around the project site. ‡ housing benefits including houses to the landless affected families in both rural and urban areas. ‡ wage employment to the willing affected persons in the construction work in the project. 01/01/2010 267 .Rehabilitation and Resettlement Policy: ‡ training and capacity building for taking up suitable jobs and for self-employment. ‡ scholarships for education of the eligible persons from the affected families. and other benefits.

2002: ‡ Objectives of the industrial park: setting up of  an Industrial Model Town for development of industrial infrastructure for carrying out integrated manufacturing activities including research and development  an industrial park for development of infrastructural facilities or built-up space with common facilities  the Growth Centre is distinctly developed as a separate profit centre.Industrial Park Scheme. 01/01/2010 268 .

including foreign direct investments. 01/01/2010 269 .National Design Policy: ‡ FDI Policy: See the detailed chart in the notes: ‡ National Design policy: Objectives:  preparation of a platform for creative design development.6. in design services and design related R & D. design promotion and partnerships  presentation of Indian designs and innovations on the international arena  attracting investments.

National Design Policy:  global positioning and branding of Indian designs  well defined and managed regulatory.6.  making India a major hub for exports and outsourcing of designs and  creation of awareness among manufacturers and service providers. promotional and institutional framework raising Indian design education to global standards of excellence. particularly SMEs and cottage industries 01/01/2010 270 .

leather.  Formulation of a scheme for setting up Design Centres/Innovation Hubs 01/01/2010 271 . toys & games which will provide common facilities and enabling tools like rapid product development. high performance visualisation. Jewellery.National Design Policy: ‡ Action plan :  Setting up of specialised Design Centres or ³Innovation Hubs´ for sectors such as automobile and transportation. etc. soft goods.6. electronics / IT hardware products.

6.  four more National institutes of Design on the pattern of NID will be set up in different regions of the country 01/01/2010 272 .National Design Policy:  Preparation of a mechanism for recognising and awarding industry achievers in creating a brand image  Encouraging Indian firms and institutions to develop strategic alliances with design firms and institutions abroad to gain access to technology and know-how improving Indian design.

6.National Design Policy:  Encouraging the teaching of design in vocational institutes oriented to the needs of Indian industry  Organising workshops and seminars  encourage and facilitating a culture for creating and protecting intellectual property in the area of designs 01/01/2010 273 .

16. Sundergarh District in Orissa and Akaltara in Chhattisgarh.  Five coastal sites at:.Mundra in Gujarat. Tilaiya in Jharkhand. Tadri in Karnataka. and Cheyyur in Tamil Nadu.000 crore.Sasan in Madhya Pradesh. Krishnapatnam in Andhra Pradesh. Girye in Maharashtra.  Four pithead sites at :. approximately 4000 MW each involving an estimated investment of about Rs.6.Ultra mega power project (UMPP):  These are very large sized projects. 01/01/2010 274 .

Assam. Sikkim will also be included. 2007:  The North East Industrial Policy (NEIP). 1997 announced on 24. Nagaland and Tripura.6.1997 covered the States of Arunachal Pradesh.  Under NEIIPP.will be eligible for incentives for a period of ten years from the date of commencement of commercial production. Meghalaya.12.  Duration of incentives: All new units as well as existing units which go in for substantial expansion. Manipur. Mizoram.Now some of the States: ‡ North East Industrial and Investment Promotion Policy (NEIIPP). 2007. 01/01/2010 275 .

6.NEIIPP  Excise duty exemption: 100% Excise Duty exemption  Income Tax Exemption: 100% Income Tax exemption  Interest Subsidy: Interest Subsidy will be made available @ 3% on working capital loan  Incentives for Service/other Sector Industries : A number of tax concessions: ‡ Capital Investment Subsidy: Capital Investment Subsidy will be enhanced from 15% of the investment in plant and machinery to 30% 01/01/2010 276 .

30 lakhs as was available under NEIP. ‡ Incentives for Bio-technology industry: ‡ The biotechnology industry will be eligible for benefits under NEIIPP. 01/01/2010 277 .6.1. 1997. 2007 as applicable to other industries.5 crores per unit. ‡ Incentives for Power Generating Industries: ‡ Power Generating plants will continue to get incentives as governed by the provisions of the Income tax Act.NEIIPP ‡ the limit for automatic approval of subsidy at this rate will be Rs. as against Rs.

‡ Transport Subsidy Scheme -2007: ‡ It covers all North eastern region 01/01/2010 278 .6.NEIIPP ‡ ‡ ‡ ‡ ‡ Industries Not Eligible: tobacco and manufactured tobacco substitutes. Pan Masala Plastic carry bags of less than 20 microns Goods produced by petroleum oil or gas refineries.

NEIIPP ‡ Transport subsidy is paid on the transport cost of raw material brought into and finished goods which are taken out. ‡ It is available at the rate of 90% within north eastern region and at the rate of 50%for finished good from this region to other region.6. ‡ Centre gives various financial assistance limited to one-third of total cost of infrastructural development 01/01/2010 279 .

6.23.Maharashtra«.849. more than 60% higher than the national average ‡ Contributes 22% in organised industrial sector ‡ 40% of internet users are from Maharashtra ‡ 30% of software export ‡ Well set mechanism to support industry 01/01/2010 280 .Incentives: ‡ Ranks first among the states in terms of State domestic production accounts for 15% of the national income ‡ Per capita income of Rs.

at more than 14000MW ‡ More than 215 industrial estates. including 9 five star industrial estate and 63 growth centers ‡ 301 engineering degree/ diploma colleges ‡ ITI¶s with turnout of 160000 technocrats every year ‡ Literacy rate at 75% 01/01/2010 281 .Maharashtra«.6.Incentives: ‡ Highest power generation capacity.

Maharashtra :Policies and Incentives ‡ A) New Micro & Small Manufacturing Enterprises. (See the Tables for A and B in the Notes) 01/01/2010 282 .6. hosiery. Medium Enterprises / LSI (including IT/ BT units) ‡ B) Interest subsidy: All new eligible Micro & Small Manufacturing Enterprises in textile. knitwear and readymade garment sector will be eligible for interest subsidy in addition to Industrial Promotion Subsidy.

6. D. Information Technology (IT) and Bio-Technology (BT) units will also be exempted from payment of Electricity Duty for a period of 10 years. ‡ D) Waiver of Stamp Duty: ‡ C.Maharashtra :Policies and Incentives ‡ C) Exemption from Electricity Duty: ‡ 100% Export Oriented Units (EOUs). D+ Talukas and No Industry Districts ± Exempted ‡ A and B areas: ‡ BT and IT units in public Parks : 100% ‡ BT and IT units in private Parks : 75% ‡ Mega Projects : 50% 01/01/2010 283 .

‡ As per the latest data of Centre for Monitoring Indian Economy (CMIE) of January 2003. 01/01/2010 284 .Gujarat ‡ 5 per cent of the India¶s total population ‡ 6 per cent of geographical area ‡ Gujarat contributes to 16 per cent of the country¶s total investment ‡ 10 per cent of expenditure ‡ 16 per cent of exports ‡ 30 per cent of stock market capitalization ‡ The state¶s annual growth rate has been 10 to 12 per cent for the last five years. Gujarat stands first in industrialization in India.6.

4% per annum ‡ Gujarat achieved as much as 35% of augmentation in its power generation capacity ‡ Three LNG terminals to come up.6. ‡ one of the first few states in India to have encouraged private sector investment in the infrastructure. ‡ Gujarat¶s State Domestic Product (SDP) rising at an average growth rate of 12.958 crore are under implementation.Gujarat ‡ Projects worth Rs. 33. 01/01/2010 285 .

1 major.6. ‡ Longest coastline of 1600 kms. dotted with 41 ports. ‡ Excellent road network ± exceeding 74000 kms. 11 intermediate and 29 minor ports. ‡ Highest number of Airports in India ± 11 including an international airport in Ahmedabad.Gujarat ‡ Gujarat accounts for almost 21% share in the export basket of India. 01/01/2010 286 . ‡ An extensive rail network connecting all major centers in the state.

‡ Industrial Policy 2003 ‡Growth Policy ‡ Power Policy ‡ Tourism Policy ‡ Road Policy ‡ Port Policy ‡ Mineral Policy 2003 ‡IT Policy 2006 ± 2011 ‡BT Policy 2007 .6.Gujarat ‡ Largest producer of Salt and Soda Ash in the country.2012 ‡Disaster Management Policy 01/01/2010 287 . ‡ Largest grass-root Petroleum Refinery in the world operational at Jamnagar.

2000 (Growth Policy) ‡ Aims to achieve sustainable industrial development  Makes the State more attractive to accelerate further the flow of investment  Proposes to promote IT and knowledge based industries  Enhanced exports from industrial units targeted  Encourages the development of small scale industries and service sector industries 01/01/2010 288 .GUJARAT INDUSTRIAL POLICY .6.

GUJARAT INDUSTRIAL POLICY .2000 (Growth Policy)  Promotes industries in backward areas  Assistance for activities like market development and promotion  Upgradation of entrepreneurial skill of first generation entrepreneurs  Asset management fund introduced to cover debt and equity fund for financial assistance to infrastructure projects  Encourages setting up of private sector industrial parks 01/01/2010 289 .

2000  Incentive Scheme for Export Oriented Park and Export Oriented Units  Insertion of additional items of production in the Sale Tax Eligibility Certificate  Medium and Large Industries .6.2000  Interest Subsidy or State cash subsidy to Small Scale Industries  Scheme of Interest Subsidy to Service Sector Industries  Industrial Park Scheme .Schemes under Gujarat Industrial Policy .Subsidy Scheme 2000 01/01/2010 290 .

.6..Gujarat Industrial Policy ± 2000. transmission and distribution 01/01/2010 291 . Power Policy:  Assistance for Research & Development and Patent Registration  Amendment in Financial Assistance for upgradation of quality in SSI/ Medium & Large Scale Sector  Declaration of Backward Talukas eligible for benefits ‡ POWER POLICY (HIGHLIGHTS)  building up adequate capacity in generation.

Gujarat Industrial Policy ± 2000.6... Power Policy:  Achieving optimum utilisation of existing equipments  Rationalizing the tariff structure  Improving quality of services thereby achieving cost effectiveness  Striving for energy conservation  Encouraging power generation utilising nonconventional sources 01/01/2010 292 .

‡ Encouraging shipbuilding. ship repairing and manufacturing facilities 01/01/2010 293 .PORT POLICY --HIGHLIGHTS ‡ Enhancing Gujarat¶s Share in EXIM Sector ‡ Decongesting the overburden on existing ports ‡ Developing / upgrading port facilities at 10 locations. ‡ Providing port facilities to promote exportoriented industries and port-based industries entailing almost 50% of total industrial investment.6.

PORT POLICY --HIGHLIGHTS ‡ Promoting coastal shipping for passengers and cargo traffic between various locations within and outside of the state. 01/01/2010 294 .6. ‡ Supporting power plants by offering exclusive facilities for import of different power fuels. ‡ Attracting private sector investment in minor and intermediate ports as also at the new port locations.

25 lakhs whichever is less.IT Policy 2006 ± 2011 ‡ Capital Incentive Subsidy: New IT unit will be entitled to avail capital subsidy @25% of eligible total capital investment or Rs. ‡ Turnover incentives: ‡ Connectivity incentives: 01/01/2010 295 . ‡ Special Incentives: There will be Special Incentives scheme for the projects with large capital base.6.

1 in availability of skilled manpower in India. ‡ Low cost of Man power. ‡ Ranks No. ‡ Largest tour-out of Engineers Technicians (1.30.Tamilnadu: ‡ One of the top three recipients of Foreign Direct Investment (FDI). ‡ Tamilnadu has 3 major Ports: Chennai Ennore and Tuticorine with twin port advantage at Chennai and Ennore apart from 14 minor Ports. Lower cost of living.6.000 from a network of 252 Engineering Colleges & 210 Polytechnics). 01/01/2010 296 .

‡ A total road network of 150.000 kms. ‡ Single window facilitation to complete preproject documentation. ‡ Prompt allotment of land in the industrial parks with supporting infrastructure.6. ‡ The only Power surplus state in India. 01/01/2010 297 .Tamilnadu: ‡ 270 passenger flight and 28 cargo flights per week at Chennai Airport-The Largest in South India.

6. access roads and other supporting infrastructure. ‡ Incentive Schemes ‡ Most Backward Areas ‡ Backward Areas ‡ Electronic Industries ‡ Leather Industries ‡ Floriculture Units ‡ Selected Category of Industries ‡ Mega projects 01/01/2010 298 .Tamilnadu: ‡ Power and water supply.

6.20 lakhs.Tamilnadu: Effluent Treatment Plants Purchase of Generators Employing Women Workers Subsidy for Most Backward Areas : subsidy of 20% of fixed assets with a ceiling of rs.15 lakhs ‡ Special Subsidy for Electronic Industries : 20% on eligible fixed assets subject to a ceiling of RS. ‡ ‡ ‡ ‡ 01/01/2010 299 . 20 lakhs ‡ Subsidy For Backward Areas: A Capital Subsidy of 15% on eligible fixed assets subject to a ceiling of Rs.

Tamilnadu: ‡ Special Subsidy for Leather Industries : a Special SUBSIDY of 20% on eligible fixed assets subject to a ceiling of RS. 01/01/2010 300 .5 lakhs. medium or major) where more than 30% of the total workers employed are women shall be eligible for an additional Capital Subsdiy of 5% of investment in eligible fixed assets subject to a ceiling of Rs.00 lakhs.6.20. ‡ Additional Subsidy for Employing Women Workers : New Industrial units ( small.

00 lakhs.6. ‡ Generator subsidy for certain industry: 15% of cost of generator subject to maximum of rs 15lakhs.Tamilnadu: ‡ Subsidy for Floriculture Units :capital subsidy of 20% on eligible fixed assets subject to a ceiling of Rs.20. ‡ Special Subsidy For Selected Category of Industries 01/01/2010 301 .

iii) Solar Energy Equipment and non conventional energy devices. ‡ ii) Drugs and Pharmaceuticals.Tamilnadu: ‡ A Special Subsidy of 10% on eligible fixed assets. iv) Export oriented Gold jewellery making and Diamond processing v) Pollution Control Equipments vi) Jute Industry vii) Sports goods and accessories viii) Food Processing Industry 01/01/2010 302 .6.15 lakhs ‡ i) Automobile Spare Parts. a ceiling of Rs.

‡ Regulations are the basis for steady growth ‡ They govern that everything occurs in conformity with plans & policy adopted 01/01/2010 303 . Legal aspects of Project Management: ‡ Legal aspects of Project Management: ‡ The Project team should have a fundamental understanding of the legal statutes which regulate their work. In the normal course of Project execution.6.

Legal aspects of Project Management: ‡ They are the process by which we check whether or not: plans are being adhered to  Environment is safe from pollution  Law & order is maintained t ‡  Any deviations for which a corrective actions needs to be taken ‡ The Project Team is expected to be conversant with the following acts: ‡ The Indian Contract Act.6. ‡ State industries act 01/01/2010 304 .

‡ ‡ ‡ ‡ ‡ ‡ ‡ ‡ 01/01/2010 305 . 1948 Income tax act. The Insolvency Act. The Laws relating to Transports _Carriage of Goods Act. Central Excise and Customs. Acts relating to Life and General Insurance. ‡ The laws relating to Sales Tax.6. The Acts: The factories act. 1981 Central sales tax & state sales tax acts The Sale of Goods Act. The Negotiable Instruments Act.

1948. ‡ ‡ ‡ ‡ ‡ 01/01/2010 306 . Pension Funds/Gratuity. Minimum wages act. The laws relating to mortgages. The laws relating to land acquisition and Land Disputes. Transfer of Property Act. 1952. Land Ceiling Act. Employees State Insurance Act. ‡ Labour Legislations ±Payment of wages act. 1936. 1948. Employees Providend Fund Act.6. The Acts: The Foreign Exchange Management Act (FEMA). Industrial Disputes Act. Major Port Trust Act.

‡ The Companies Act.6. The Acts: ‡ Legislations concerning Environmental Pollution. ‡ And many more which are relevant to the activities that are undertaken in the execution of the Project. which pervades or touches upon every business activity. The most important of all is the Contract Act. 01/01/2010 307 .

Transfer of Property Act. Law of Agency: The Project Manager should remember that he is an Agent of the owners of the Project and is answerable to them for his actions even when they are bona-fide. 01/01/2010 308 . ‡ Hence a thorough understanding of the Contract Act is a must for a Project Manager. Etc. Contract Act ‡ Some of the situations arising out of contracts are more specifically dealt in other Acts ± like the Sale of Goods Act.6.

6. ‡ In case of emergencies. 01/01/2010 309 . as would be done by a person of ordinary prudence would do to protect his interests in similar circumstances. Contract Act ‡ An agent cannot do what the principal himself cannot do. the Project Manager ( as the agent) has the authority to do every lawful thing necessary for the purpose of protecting his principal from loss.

Contract Act ±IDR Act ‡ When an Agent does more than what he is authorised to do. Industries Development and Regulation Act : ‡ The Act Provides The Conceptual And Legal Framework For Industrial Development And Industries In India 01/01/2010 310 .6. and if the unauthorised acts of the agent can be separated from the authorised acts. then the Agent is liable for the consequences of the unauthorised acts.

The IDR Act ‡ The Licensing Policy For Industries Is Determined Under This Act. ‡ ----Investment of unit in fixed assets --Nature of ownership: --Smallness of number of workers employed --Nature. ‡ The Act Specifies The General Requirements That Are To Be Complied With By Small-scale Units. 01/01/2010 311 . cost and quality of product etc ‡ Section 29-B provides reservation of products for exclusive production in the small-scale sector.6.

The IDR Act ‡ The Act specifically refers to only two categories of the small-scale sector: -Small Scale Industrial undertaking . 01/01/2010 312 .Ancillary Industrial Undertaking ‡ It is capable enough of meeting the consumer goods needs of the community ‡ The government should keep the interest of community at uppermost in time ‡ Provide a support from large houses & safeguard the interest of millions of those who depend on it for their livelihood.6.

or 20 or more workers without power or were working any day of the preceding 12 months 01/01/2010 313 . and welfare of workers in factories.6.The Factories Act. which governs the health. 1948 ‡ The Factories Act is the principal legislation. safety. ‡ A factory under the Act is defined as a place using power. employs 10 or more workers.

6. ‡ Section 11 to 20 deal with various provisions such as: ‡ Environmental sanitation that protect the worker from hazardous environment. ‡ The Act does not permit the employment of women and young in a dangerous process or operation.The Factories Act. 01/01/2010 314 . 1948 ‡ Electronic Data Processing Unit or a Computer Unit is installed shall not be considered at a factory if no manufacturing process is being carried on in such premises.

overcrowding (minimum of 50 cubic meters per person) are specified ‡ Safety measures like fencing of machines. etc. stairs.6. are explained ‡ Disposal of wastes and effluents should be without any risk ‡ Ventilation. wall etc. benches. dangerous fumes. 1948 ‡ Cleanliness of the working place. protection of eyes against fire. temperature inside factory. dust and fumes emission. lighting.The Factories Act. are defined 01/01/2010 315 . artificial humidification. privy.

first aid appliances are provided. and not more than 48 hours of working in a week. canteens. ‡ There is provision for one weekly holiday. 1936 ‡ It has been enacted to regulate the payment of wages to workers employed in certain specified industries and to ensure a speedy and effective remedy to them against illegal deductions or unjustified delay caused in paying wages to them.The Factories Act. 01/01/2010 316 . Payment of Wages Act.6. 1948 ‡ Facilities for sitting.

‡ 01/01/2010 317 .The Factories Act. 1600/.a month.e in current coin or currency notes or both.6. industrial or other establishment or in a railway ‡ The act is applicable to employees drawing wages upto Rs. i. ‡ All wages shall be paid in current legal tender. 1948 ‡ It applies to the persons employed in a factory. ‡ The person responsible for payment of wages shall fix the wage period upto which wage payment is to be made.

‡ Although the wages of an employed person shall be paid to him without deductions the act allows deductions from the wages of an employee on the account of the following:‡ fines Absence from duty Damage to or loss of goods by the employee Housing accommodation and amenities provided by the employer Recovery of advances or adjustment of over-payments of wages Recovery of loans made from any fund 01/01/2010 318 .6. 1948 ‡ All payment of wages shall be made on a working day.The Factories Act.

The Factories Act. Without Any Unauthorized Deductions 01/01/2010 319 . The Main Objective Of The Act Is To: ‡ Eliminate All Malpractices ‡ By Laying Down The Time And Mode Of Payment Of Wages ‡ Securing That The Workers Are Paid Their Wages At Regular Intervals.6. 1948 ‡ Hence.

strikes. handling of disputes. come under this section. Providend/ Pension contributions to the Providend Commissioner¶s Office within the stipulated time schedule etc.  So many issues like payment of proper wages at the proper time.Labour Laws: Labour Laws: This is probably the most important and sensitive issue in Project Management.6. towards Employees State Insurance. severance packages. remittance of dues to the Govt. 01/01/2010 320 .

Labour Laws:  So. 1952 ‡ The main objective of making some provisions for the future of industrial workers after their retirement and for their dependents in case of death. discharge. Employees' Provident Fund and Act. 01/01/2010 321 . retirement. ‡ It provides insurance to workers and their dependents against risks of old age. the Project Manager has to take care to see that his team members handle such items carefully. retrenchment or death of the workers.6.

1952 ‡ Employees' Deposit Linked Insurance Scheme.Labour Laws: ‡ The Act is administered by the Government of India through the Employees' Provident Fund Organization (EPFO ‡ Three Schemes Are In Operation Under The Act: ‡ Employees' Provident Fund Scheme. 1995 (Replacing The Employees' Family Pension Scheme.6. 1976 ‡ Employees' Pension Scheme. 1971) 01/01/2010 322 .

6.Labour Laws: ‡ To provide the employees an old age and survivorship benefits ‡ A long term protection and security to the employee and after his death to his family members ‡ Timely advances including advances during sickness and for the purchase/ construction of A dwelling house during the period of membership. 01/01/2010 323 .

01/01/2010 324 .6. Sales of Goods Act Sale of Goods Act: Sale contract is a bilateral contract with money consideration being a must for the sale of goods and the exact moment when the title passes on to the buyer from the seller defined clearly in the Act.

01/01/2010 325 .6. or the Project Finance Department might not have made the agreed payment in full. ‡ Any of these may cause a delay in use of the goods in question affecting the time schedule of the project. quantity or quality etc. the seller might not have delivered the goods as agreed as per time. Sales of Goods Act ‡ The Project Manager and his team should know the intricacies of this act as they may have to face many tricky situations ± for example.

Sales of Goods Act  Central Sales Tax Act: Most of the states have agreed to change over to the µVAT¶ system.6. 01/01/2010 326 . There are differing Tax laws governing sale of goods within a state (State Sales Tax Acts) and from a place in one state to a place in another State (CST) and now the VAT.  The Project Manager and his team should be aware of the consequences of not loading the appropriate tax amount in the goods purchased for the project as any subsequent claim by the seller of the goods or the Tax authorities would inflate the cost of the project.

01/01/2010 327 .6. Carriages of Goods Act Carriage of Goods Act: A contract of carriage of goods is a contract entered into between parties for transportation of goods from the point of dispatch to the point of destination. Since the goods meant for the project have to be transported the Project Manager has to be aware of the implications of the duties and responsibilities of the sending and the receiving parties.

or for the foreign architects/technicians towards their compensation. But part of the responsibility falls on the customer also.6. FEMA comes into picture and care has to be taken to see that there are no violations. Foreign Exchange Management Act (FEMA)  Foreign Exchange Management Act (FEMA): When goods are exported or imported or any payments are remitted abroad towards royalty or fees paid for technical drawings/designs.  Here the Bankers who deal with such transactions will guide the Project Manager properly. 01/01/2010 328 .

01/01/2010 329 . endorsers and endorsees all have their rights and responsibilities and hence the Project Manager and his team should be fully aware of these nuances and act carefully while handling the Negotiable Instruments. ‡ The makers. Negotiable Instruments act (NI Act) Negotiable Instruments Act: This deals with the Negotiable instruments ± Promissory Notes. payees.6. Cheques and Drafts. Bills of Exchange.

6. Legal aspects of Project Management: 
Bailment, Indemnity : These are coming out of contracts and separately elaborated. Bailment is delivery of goods by one person to another for some purpose like safe keeping etc. The bailer and the bailee have their own rights and responsibilities. ‡ The contract of Indemnity is defined as a contract between the promisor called the Indemnifier and the promisee called the indemnified whereby the former undertakes the responsibility of compensating any loss that the latter may suffer due to his own conduct or due to conduct of some one else. It is essentially a contingent contract.
01/01/2010 330

6. Legal aspects of Project Management: 
The Excise Act: Excise is an indirect tax and is paid by the seller to the government before sending out the goods out of the factory premises and recovered from the buyer along with the price of goods.  Any goods which is sold directly from the factory premises, should always accompany the µExcise Gate Pass¶ while on the move signifying the fact that the excise dues have been paid to the Govt.  Otherwise the Excise dept. has the powers to seize the goods . Such incidents will invariably delay the project execution. 01/01/2010 331

6. Legal aspects of Project Management: 
Octroi Duties: These are levied by many Panchayats/ Municipalities/Corporations when goods of value enter their territory ± except for the goods which are in transit through their territory or those which are being transported to the ports/rail heads.  Clearing the goods in Octroi check posts is a time consuming process and so the Project Management should make allowance for these delays in their project schedule.

01/01/2010

332

6. Legal aspects of Project Management: 
Acts relating to Insurance: When the goods meant for the project are on the move or stored there are chances of damage and hence care has to be taken to see that the goods are covered by insurance for the value of the goods with the appropriate clauses or riders so as to minimise the losses.  Similarly when unfortunately any of the project employees die while on duty,««

01/01/2010

333

6. Legal aspects of Project Management:
‡ «the heavy financial compensation that may have to be paid to the family of the deceased may be shared with a Life Insurance company through µGroup Life Insurance Policies¶ which will cover all the employees.

01/01/2010

334

7.Financial analysis-Profitability Analysis.
‡ Financial analysis refers to the process of obtaining relevant economic information about a project in order to establish its financial viability. It is undertaken as one of the feasibility analyses in project formulation. ‡ Financial analysis can be defined as the process of discovering economic facts about an enterprise and or a project on the basis of an interpretation of financial data. It also looks at the capital cost, operations cost and operating revenue.
01/01/2010 335

7.Financial analysis-Profitability Analysis.
‡ Most of the data required for financial analysis are obtained from market analysis, technical analysis and cost analysis. ‡ Then the data is converted and presented in the form of Proforma Balance Sheet, Proforma Operating Statement and Cash Flow statements. ‡ Financial analysis primarily deals with the interpretation of the financial data incorporated in the Proforma financial statements and the presentation of the economic facts in such a form as to make a comparative evaluation/appraisal of projects.
01/01/2010 336

7.Financial analysis-Profitability Analysis.
‡ Financial analysis can provide insight into two important areas of management ± Return on Investment and soundness of the company¶s financial position. ‡ A financial analysis reveals where the company stands with respect to profitability, liquidity, leverage and an efficient use of its assets.

01/01/2010

337

7.Financial analysis-Profitability Analysis.
‡ In order to complete the financial profile of a project, it is also necessary to evaluate the operational strategy and the investment strategy of the project. The break even analysis is used to explain its operational characteristics. ‡ The financial strategy is evaluated in terms of financial leverage.

01/01/2010

338

7.Financial analysis-Profitability Analysis.
‡ The parties who have a stake in the financial results of a company are: D Creditors DPotential suppliers Ddebenture holders Dcredit institutions like banks Dindustrial finance corporations Dpotential investors Demployees Dtrade unions Dimportant customers Deconomists D investment analysts Dtaxation authorities DGovts. et al. They all look at the financial statements from different angles.

01/01/2010

339

7.Financial analysis-Profitability Analysis.
‡ The principal financial tools that are relevant in this context are: htrend analysis hvariable analysis hRatio analysis hFunds Flow analysis hBreak even analysis hCommon size analysis hCash Budgets ‡ Investment criteria: NPV; Benefit Cost Ratio; IRR; Pay Back period; Accounting Rate of Return. ‡ The NPV of a project is the sum of the present values of all the cash flows-- positive as well as negative²that are expected to occur over the life of the project:

01/01/2010

340

NPV
‡ The general formula for NPV is: n NPV = 7 Ct t =1 ----------- initial investment (1 +r) t --where Ct = cash flow at the end of year t; n = life of the project in years; and r = discount rate. ‡ (See an example in the text book ± PC 8.2 to8.9 and do some homework assuming some figures)

01/01/2010

341

NPV
‡ The NPV represents the net benefit over and above the compensation for time and risk. ‡ Hence the decision rule associated with the NPV criterion is : --Accept the project if the NPV is +ve and --Reject if the NPV is ±ve. (If NPV is 0, then the result is indifferent i.e. the selection of the project has to depend on other factors, since the project is neither a profitable nor a losing proposition)

01/01/2010

342

NPV
Properties of the NPV Rule: ‡ Value of a firm = 7 PV of existing projects + 7 NPV of future projects ‡ When a firm terminates an existing project which has a negative value, the firm¶s value increases by that amount. ‡ On the same lines, if a new project with an expected negative NPV is undertaken, the value of the firm decreases by the same amount.

01/01/2010

343

NPV
‡ When a firm divests an existing project, the value of the firm increases or decreases as the case may be by the same amount of positive or negative difference of the price received over the expected NPV. ‡ Conversely when a firm acquires an existing project, its value will increase or decrease as the case may be by the same amount of negative or positive difference of the price paid over the expected NPV;

01/01/2010

344

NPV
‡ Even if a firm takes up new projects with positive NPV, the value of the firm may decrease if it falls below the expectations of the investors. ‡ The NPV rule assumes that the cash flows that occur in between the initial outflow and the termination of the project are reinvested at the cost of capital.

01/01/2010

345

the formula seen earlier has to be slightly amended as follows: n NPV = 7 Ct t =1 ----------.NPV ‡ Different discount rates for different periods may also be used in which case. and rt = discount rate for the year t..initial investment (1 +rt)t where Ct = cash flow at the end of year t. n = life of the project in years. 01/01/2010 346 .

NPV
‡ This formula can again be further refined as follows: n NPV = 7 Ct t =1 ----------- - initial investment t 4 (1 +rj)t j=1 where Ct = cash flow at the end of year t; n = life of the project in years; and rj = one period discount rate. (Can you explain this concept ?) See the textbook ± PC 8.2 to 8.9 - for an example worked out with this formula.
01/01/2010 347

NPV
‡ The discount rate may change over time due to the reasons that : Dthe change in the level of interest rates over time, Dthe risk characteristics of the project may change over time resulting in the change in the cost of capital; Dthe financing mix of the project may undergo change over time resulting in the changes in the cost of capital.  NPV of a project decreases as the discount increases.
01/01/2010 348

Modified NPV
‡ Modified NPV: This is another method of finding the NPV, when the intermediate cash flows are reinvested at a rate different from the cost of capital and is slightly complicated than the earlier method. ‡ The steps are as follows: First calculate the Terminal Value (TV) of the project¶s cash flows using the project¶s defined reinvestment rate which is expected to reflect the profitability of the investment opportunities in the years to come.
01/01/2010 349

Modified NPV
‡ TV = 7 (t = 1 to n) CFt (1+r¶)n-t Where TV = terminal value (i.e. future value) of the project¶s cash flows; - CFt = Cash Flow at the end of year t; - r¶ = reinvestment rate applicable to the cash inflows of the project. ‡ Next determine the Modified NPV using the formula: ‡ NPV* = {TV/(1+r)n} - I , where NPV* = Modified NPV; TV = Terminal Value ; r= cost of capital and I = Investment outlay.
01/01/2010 350

Modified NPV
‡ See an example in the text book ±PC 8.8 to 8.9. ‡ Limitations of NPV method: h It ignores the relative terms and the scale of investment but gives the absolute terms ; h the life of the project is ignored ( If two projects with different lives return the same absolute NPV, it implies that the method favours the one with longer life).

01/01/2010

351

Benefit Cost Method:
‡ Benefit Cost Method: Two methods are adopted: ‡ B-C Ratio : BCR = PVB/I and ‡ Net BCR = NBCR = (PVB-I)/I = BCR ± 1.

The decision rules are: When BCR >1 =1 <1
01/01/2010

or

NBCR >0 =0 <0

Rule is : Accept Indifferent Reject
352

Benefit Cost Method:
‡ Both the methods indicate the same direction ‡ Since the criterion measures the NPV PER RUPEE INVESTED, it can discriminate between small and big projects and short and long term projects and so better than the NPV criterion. ‡ The draw back is that it provides no means for aggregating several small projects into a package to compare with a larger project. Also when there are cash outflows beyond the current period, it is unsuitable.

01/01/2010

353

Internal Rate of Return (IRR):
‡ Internal Rate of Return (IRR): . ‡ The IRR of a project is the discount rate which makes its NPV = 0. ‡ In other words, is the discount rate which equates the present value of future cash flows with the initial investment. It is the value of µr¶ in the following equation: ‡ Investment = 7 (t = 1 to n) Ct/(1+r)t ‡ Where Ct = cash flow at the end of year t; r = IRR and n = life of the project.

01/01/2010

354

Internal Rate of Return (IRR):
‡ In the following example, where the cash flows are: -1,00,000, 30,000, 30,000, 40,000 and 45,000, the IRR is the value of r which satisfies the equation: Rs. 1,00,000 = Rs.30000/1+r) + 30000/(1+r)2 + 40000/(1+r)3 + 45000/(1+r)4

01/01/2010

355

Internal Rate of Return (IRR):
‡ The calculation of r involves a process of trial and error. ‡ At 15%, the NPV = Rs.1,00,802 and at 16%, it is 98,641. ‡ By interpolation it is found to be 15.37%. (Excel has a ready formula for calculating the IRR which is widely used) ‡ The Decision Rule is : Accept if the IRR is > cost of capital and Reject if the IRR is < the cost of capital
01/01/2010 356

NPV and IRR
Comparison of NPV and IRR: ‡ To find the linkage between the two, let us plot the NPV on the Y axis and the rate of return on the x axis. ‡ The IRR is the point at which the NPV profile crosses the x axis and the slope of the NPV profile reflects how sensitive the project is to discount rate changes.

01/01/2010

357

NPV and IRR

NPV

i

nt rat

01/01/2010

358

NPV and IRR
‡ Whether the IRR rule and the NPV rule lead to identical decisions? ‡ Yes, if: 1. the cash flows of the project are conventional, that is the first cash flow is negative and the other following cash flows are positive. and ‡ 2. the project must be independent i.e. the project can be accepted or rejected without reference to any other project.
01/01/2010 359

IRR
‡ Problems with the IRR: ‡ When the cash flows of the project are not conventional (cash flows can be negative in between) or when two or more projects are compared to find the better one. ‡ It is either difficult to define or it can be misleading. ‡ It cannot distinguish between short term and long term projects and also when the interest rates differ and so cost of capital also changes during the project¶s life.
01/01/2010 360

IRR
‡ Consider a project with the following cash flows: -160000, 1000000, and 1000000. ‡ The IRR of the project is given by r in the equation: ‡ -160000 + 1000000/(1+r) -1000000/(1+r)2 = 0. ‡ The IRRs are 25% and 400%

01/01/2010

361

IRR
‡ We cannot say which of these IR is correct. Here the IRR rule breaks down.
NPV

25

Discount rate (percentage) 400

01/01/2010

362

bigger absolute return and smaller IRR.14) ‡ Mutually exclusive projects: Consider two projects : One with small investment. As per the IRR rule. 01/01/2010 363 . smaller absolute return and more IRR and another with bigger investment.IRR ‡ There can also be cases when the NPV is always positive and hence no IRR (See the example in book PC 8. the smaller project has to be selected which is wrong.

IRR 100% and NPV at r= 12: Rs. 7.. and B with cash flows : -50000 and 75000. IRR 50% and NPV: Rs. Hence the project can be accepted. 16964.50%.857. 01/01/2010 364 . the incremental cash flows in the case of Project B are: -40000 and 55000.IRR ‡ Example: Two projects A with the cash flows: -10000 and 20000. IRR = 37. ‡ When you look at the same projects with incremental cash flows. ‡ In the above case. which is far above the cost of capital 12 %. the IRR returns a better figure.

then the project can be accepted. ‡ If the IRR is used as a decision criterion.IRR ‡ Finally we can conclude that when we consider two mutually exclusive projects. then if the IRR> the opportunity cost. 01/01/2010 365 . it is better to rely on the NPV criterion. ‡ The case of different short and long term interest rates: ‡ Recall that the discount rates µr¶ used in the denominator for the years refer to the costs of capital for the respective years.

to avoid complications. 01/01/2010 366 . ‡ The meaning of IRR: (1) The IRR represents the return on the un-recovered investment balance in the project (at the same rate for the entire project life). the NPV method is preferred. ‡ So in such cases.if it changes from year to year? ‡ So we have to work out a weighted average of various rates and then compare it with the IRR.IRR ‡ Which opportunity cost .

‡ Since the second is not always possible we may say that the first mentioned meaning is more realistic. ‡ See the example in book PC 8.16-17 01/01/2010 367 .IRR (2) the IRR is the rate of return earned on the initial investment made in the project (at the same rate of reinvestment of intermediate flows).

‡ Samuel Weaver says: ³The resulting IRR can be compared to the expected inflation. the current borrowing rates. whereas the IRR arrives at it and so can be compared with the desired (even if not definitely known) discount rate. the cost of capital.IRR ‡ The desirable qualities of IRR: Managers look to the rate of return for their investments. ‡ Further NPV can be calculated if you know the exact discounting rate. but still may vaguely. an equity portfolio¶s return and so on´. 01/01/2010 368 .

20.60. ‡ It is that percentage at which the costs discounted at the cost of capital are compounded over the project life to produce the returns. -80.120 and the cost of capital = 15% 01/01/2010 369 .80.100. ‡ See the following example for clarification: ‡ The cash flows of a project are : -120.IRR ‡ The Modified IRR (MIRR): Whether the shortcomings of the regular IRR can be overcome? ‡ Yes by using the MIRR.

2: Calculate the terminal value TV of the cash inflows using the following equation: ‡ TV = 7 (t = 0 to n) Cash in flowt (1+r)n-1 i. 120 + 80/1. 01/01/2010 370 .15)4 + 60*(1.6 assuming a cost of capital of 15%. :20*(1.e.15)3««+ 120 = 467.e. Calculate the present value of costs using the formula: ‡ PVC + 7 (t= 0 to n) Cash flowt /(1+r)t i. 1.IRR ‡ Step No. ‡ Step no.15 = 189.

3: Solve the following equation to find MIRR: ‡ PVC = TV / (1+MIRR)n. ‡ Thus MIRR 0.IRR ‡ Step no.2%.162 or 16. 01/01/2010 371 . In this case it is: 189 = 467/(1+MIRR)6.e.2% compounded through the life of the project of 6 years. i.. the cost of the project is giving a return at 16.

Secondly. 01/01/2010 372 .IRR ‡ Evaluation: The MIRR is superior since the MIRR assumes that the project cash flows are reinvested at the cost of capital whereas the regular IRR assumes that the cash flows are reinvested at the project¶s IRR. the problem of multiple rates does not exist. in conclusion we can say that if two mutually exclusive projects have the same project size. NPV and MIRR lead to the same decision irrespective of the variations in the life of the projects. ‡ So.

150000.Pay back period ‡ Pay back period: It is the length of time required to recover the initial cash outlay on the project.100000.1000. 150000.and 100000 the pay back period is 5 years. ‡ For a project with the outflows -600000. the better it is since the risk would be less. 01/01/2010 373 . ‡ The shorter the pay back period.

‡ It does not indicate the firm¶s overall liquidity.Pay back period ‡ It ignores the time value of money and also ignores the cash flows beyond the pay back period. ‡ It is measure of the project¶s recovery of the investment and about the profitability. 01/01/2010 374 . ‡ There may be some projects with substantial cash flows beyond the Pay back period and they are all ignored.

‡ See the example in book PC 8.Discounted Pay back period ‡ Discounted Pay back period method: ‡ In the conventional Pay Back Period method the cash flows are taken as they are without recognising time value of the flows. ‡ This defect is removed by discounting the flows at the appropriate cost of capital.22-24 ‡ The pay back period method can be regarded as the reciprocal of the IRR method when the annual cash flows are constant and the life of the project is fairly long. 01/01/2010 375 .

‡ The shorter the pay back period. the faster is the uncertainty associated with the project resolved.Discounted Pay back period ‡ This method is like the Breakeven point. 01/01/2010 376 . ‡ Accounting Rate of return: ‡ The accounting rate of return is also called the average rate of return on investment.

Accounting Rate of return ‡ ‡ ‡ ‡ ‡ The common measures that are adopted are: Average Income after tax/Initial investment Average income after tax/ average investment Average income after tax but before interest/initial investment Average income after tax but before interest/average investment 01/01/2010 377 .

‡ See the example in book PC 8. 01/01/2010 378 .24-27.Accounting Rate of return ‡ Average income before interest and taxes/initial investment ‡ Average income before interest and taxes/average investment ‡ (Total income after tax but before depreciation ± initial investment)/initial investment/2) x years.

‡ Merits of the method are: ‡ Accounting rate of return method is simple to calculate. Generally.Accounting Rate of return ‡ Higher the accounting rate of return. the better is the project. those projects with accounting rate of return greater than the desired cut off rate of return are accepted. ‡ Considers the benefit over the entire life of the project. 01/01/2010 379 . ‡ Based on accounting info which is readily available.

‡ Accounting income is not defined since depreciation method is not defined. 01/01/2010 380 . ‡ Does not take into account the time value of money.Accounting Rate of return ‡ Demerits are: ‡ It considers accounting profit and not cash flow. ‡ The method is misleading since balance sheet book values reflect neither the earning capacities of the assets nor their market values.

01/01/2010 381 . ‡ Generally multiple evaluation models are used. ‡ Accounting rate of return and pay back period method are used as supplementary methods.Assessment of various methods ‡ A survey by U C Rao came out with the following finds: ‡ Discounted cash flow methods have gained importance and IRR is the most popular method.

The common methods for risk adjustment are shortening the payback period. 01/01/2010 382 . ‡ Risk assessment and adjustment techniques have gained popularity and the most popular technique is sensitivity analysis.Assessment of various methods ‡ Weighted average cost of capital is the most commonly used discount rate and the most often used discount rate is 15 %in post tax terms.

01/01/2010 383 . ‡ The methodology is used generally for public investments but it is equally important for private investments also since they have to be approved by various governmental and quasigovernmental agencies which have larger national interest in view while taking decisions.Social Cost Benefit Analysis (SCBA) ‡ SCBA is a methodology developed for evaluating investment projects from the point of view of the society as a whole.

soil erosion. ‡ The social costs are harmful to the society : like pollution of air. noise and water.SCBA ‡ The Project Manager has to study the social costs of the project and the social and economic benefits the project will generate. production of harmful products etc. 01/01/2010 384 . deforestation.

‡ In SCBA.SCBA ‡ The social and economic benefits would be: increase in employment opportunities-both directly and indirectly. ‡ The project manager has to choose the project that is beneficial to the society. concern for savings. taxes and subsidies. concern for redistribution merit wants etc. the focus is on social costs and benefits which often tend to differ from the monetary costs and benefits of the project. externalities. rise in per capita income etc. 01/01/2010 385 . ‡ The sources of the discrepancies are: market imperfections.

the official rate would be less than the market rate). ‡ and foreign exchange regulation (in countries where the exchange rates are regulated. ‡ The common imperfections are : ‡ rationing (control over price and distribution ± price paid by consumer is much less than the market price).SCBA ‡ When imperfections exist. ‡ prescription of minimum wage rates (wages that have to be paid would be more than that would be payable in a competitive labour market). market prices do not reflect social values. 01/01/2010 386 .

the project does not derive any extra benefit but the community around the project benefits without any payment. 01/01/2010 387 .SCBA ‡ Examples of externalities are: ‡ beneficial infrastructure facilities created by the project like roads which also benefit the surrounding areas ‡ or the bad effects of environmental pollution created by the project. ‡ In the first case.

These are relevant for SCBA. 01/01/2010 388 . In the capital-scarce developing countries. ‡ Taxes and subsidies: From the Project point of view.SCBA ‡ In the second case. a higher valuation is placed on savings and a lower valuation is put on consumption. the community around the project suffers the inconvenience but the project does not pay for it. ‡ Concern for Savings: A private firm does not have differential valuation between consumption and savings. the taxes and subsidies are monetary costs and gains but from the social point of view they are simply transfer payments.

are not relevant from private point of view but are important from social point of view. 01/01/2010 389 . a rupee of benefit going to an economically poor section is considered more valuable than a rupee of benefit going to an affluent section. ‡ Merit wants ±like adult education programme or a balanced nutrition programme for school going children .SCBA ‡ Concern for redistribution: From the social point of view.

‡ The UNIDO approach has been laid out in their publications: µGuidelines for Project Evaluation¶ 1972 and µGuide to Practical Project Appraisal¶ 1978. ‡ The method of project appraisal involves five stages.SCBA ‡ UNIDO approach: ‡ UNIDO approach and the Little-Mirrlees (µLM¶) approach emerged for SCBA in the early 1970¶s. each one measuring the desirability of the project from a different angle: 01/01/2010 390 .

‡ Adjustment for the impact of the project on merit goods and demerit goods whose social values differ from their economic values.SCBA ‡ Calculation of the financial profitability of the project measured at market prices. ‡ Adjustment for the impact of the project on savings and investment. ‡ Adjustment for the impact of the project on income distribution. ‡ Obtaining the net benefit of the project measured in terms of economic efficiency prices. 01/01/2010 391 .

When markets are perfect. ‡ Therefore there is a need to develop shadow prices and measuring net economic benefit in terms of these prices.SCBA ‡ Net Benefit in terms of Economic prices: ‡ This is also referred to as shadow prices. market prices will represent economic prices. ‡ But in reality market has so many inefficiencies which we have already discussed. 01/01/2010 392 .

01/01/2010 393 .SCBA ‡ Basic issues in shadow pricing: ‡ 1. Concept of tradability: For tradable goods the international price is a measure of its opportunity cost and hence represents the real value in terms of economic efficiency.Choice of the unit of account: UNIDO¶s answer is : ³net 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 rupees´. ‡ 2.

Sources of shadow prices: UNIDO approach suggests three sources depending on the impact of the project on the economy:: ‡ (i) increase or decrease in the total consumption in the economy: shadow pricing is the consumer¶s willingness to pay. ‡ (ii) decrease or increase in the production in the economy : --shadow pricing is the cost of production. 01/01/2010 394 .SCBA ‡ 3.

‡ (ii) When the project augments domestic production by other producers.SCBA ‡ (iii) increase or decrease in imports or exports : shadow pricing is the foreign exchange value. taxes should be excluded and 01/01/2010 395 . Taxes: (i) If a project results in diversion of non traded inputs which are in fixed supply from other producers or addition to non traded consumer goods : taxes should be included. ‡ 4.

‡ Shadow pricing of specific resources: ‡ Tradable inputs and outputs: A good is fully traded when an increase in its consumption results in corresponding increase in import or decrease in export or when an increase in its production results in a corresponding increase in export or decrease in import. 01/01/2010 396 . taxes should be ignored.SCBA ‡ (iii) for fully traded goods.

‡ It should be measured in terms of what domestic consumers are willing to pay if the output of the project adds to its domestic supplies or if the requirement of the project causes reduction of its consumption by others. the border price does not reflect its economic value. ‡ For non traded goods. the shadow price is the µborder price¶ which is the domestic currency equivalent converted at the market exchange rate. ‡ In practice.SCBA ‡ For fully traded goods. it is reasonable to regard tradable inputs and outputs as fully traded. 01/01/2010 397 .

and its FOB export price is less than the domestic cost of production.SCBA ‡ The value of a non traded good should be measured in terms of its marginal cost of production if the requirement of the project induces additional production or if the output of the project causes reduction of production by other units. 01/01/2010 398 . ‡ Non tradable inputs and outputs: ‡ A good is non tradable when : its CIF import price is greater than the domestic cost of production.

‡ (iii) which is not traded in the market place.SCBA ‡ Externalities: an externality is a special class of good: ‡ (i) which is not deliberately created by the project sponsor but is an incidental outcome of legitimate economic activity. 01/01/2010 399 . for better or for worse. (ii) which is beyond the control of the persons who are affected by it.

SCBA ‡ Some examples already referred to earlier are: ‡ roads built by factory being very useful for the people around the factory or a factory emitting emissions causing injury to the health of the population around the factory etc. ‡ The valuation of external effects is very difficult. Because they are intangible in nature but can be estimated by indirect means: 01/01/2010 400 .

the value of better transport provided by the approach road built by a factory may be estimated in terms of increased activities and benefits derived there from. 01/01/2010 401 .SCBA ‡ For example. ‡ The cost of pollution may be estimated in terms of the loss of earnings as a result of damage to health caused by it and the cost of time spent for coping with the unhygienic surroundings.

It may induce the production of new workers-the social cost would be the amount of leisure that the labour foregoes. the additional consumption of food that the labour would now have as a result of increased wages and the cost of training that the worker has to undergo to improve his skills etc. 2. and 01/01/2010 402 . there can be three possible effects on the rest of the economy: 1.SCBA ‡ Labour inputs: When a project hires labour.It may take labour away from other employments ± shadow price would be what other users of labour are willing to pay for this labour.

‡ So the questions arise as to what is the value of the physical assets and what is the opportunity cost of the capital ? 01/01/2010 403 . --financial assets are converted into physical assets --and financial resources are withdrawn from pool of savings and therefore alternative projects are foregone.SCBA 3. ‡ Capital inputs: When a capital investment is made in a project. and it may involve import of workers ± shadow price would be the wage they command.

SCBA ‡ The shadow price of the physical assets is calculated depending on whether it is tradable or non tradable good. ‡ Foreign Exchange: The UNIDO method uses the domestic currency and so the foreign exchange inputs of the project must be identified and adjusted by an appropriate premium to reflect the shadow price of foreign exchange. ‡ And the opportunity cost of capital is measured by the consumption rate of interest which is the price the saver must be paid to sacrifice present consumption. 01/01/2010 404 .

the income gained or lost by individual groups within the society must be measured first. ‡ The gain or loss to an individual group within the society as a result of the project is equal to the difference between the shadow price and market price of each input or output in the case of physical resources ‡ or the difference between the price paid and the value received in the case of financial transactions.SCBA Measurement of the impact on distribution: ‡ For such assessments. 01/01/2010 405 .

( Yi = change in income of group i as a result of the project and MPSi = marginal propensity to save of group i. ‡ The second question is: What is the value of such savings to the society? ‡ It is the present value lf the additional consumption stream produced when that rupee of savings is invested at the margin.SCBA Savings impact and its value: ‡ Here two questions are raised: ‡ Given the income distribution impact of the project what would be its effects on savings? ‡ It is equal to 7 ( Yi MPSi. where. 01/01/2010 406 .

‡ Therefore investment projects are also considered as investments for income redistribution and their contribution toward this goal is considered in their evaluation.SCBA Income distribution impact: Redistribution of income in favour of economically weaker sections or economically backward regions is a socially desirable objective. subsidy and transfer measures. ‡ This cannot happen entirely through tax. 01/01/2010 407 .

to reflect the relative value of income for different groups and summing them. which essentially reflect political judgements may be determined by an iterative process involving interaction between the analyst and the planners. ‡ UNIDO¶s guidelines suggested that the weights. 01/01/2010 408 .SCBA ‡ This calls for suitably weighing the net gain or loss by each group measured earlier.

The concept of merit goods can be extended to include a socially desirable outcome like creation of employment rather than dishing out unemployment dolls or create µfood for work¶ like jobs. 01/01/2010 409 .SCBA Adjustment for merit and demerit goods: A merit good is one for which the social value exceeds the economic value.

‡ There is considerable similarity between the UNIDO approach and the LM approach. consider the factor of equity and use of DCF analysis. ‡ Both call for calculating the shadow prices. 01/01/2010 410 .SCBA Little-Mirrlees (LM) approach: ‡ IMD Little and JA Mirrlees have developed an approach to SCBA.

the LM approach measures costs and benefits in terms of international prices (border prices). 01/01/2010 411 . ‡ The UNIDO approach measures the costs and benefits in terms of consumption whereas the LM measures in terms of uncommitted social income.SCBA ‡ The differences are: ‡ While the UNIDO approach measures costs and benefits in term of domestic rupees.

01/01/2010 412 . ‡ Shadow prices: The outputs and inputs of a project are classified into the following categories: ‡ 1. whereas the LM tends to view these considerations together. savings and redistribution considerations in different stages.SCBA ‡ The stage by stage analysis recommended by the UNIDO approach focuses on efficiency. traded goods and services-the border price (FOB for the exported goods and CIF for the imported goods).

cost of having an additional amount committed to consumption due to the higher income. and ‡ 3.these are at accounting prices defined in terms of marginal social cost and marginal social benefit. non traded goods and services . cost associated with urbanisation.SCBA ‡ 2.labour.shadow wage rate is difficult to determine in social cost and benefit analysis. ‡ It is a function of several factors: marginal productivity of labour. 01/01/2010 413 .

01/01/2010 414 .SCBA SCBA by Financial institutions: Financial institutions analyse a project from the financial profitability angle as well as from the angle of SCBA. ‡ Effective Rate of Protection (ERP) ‡ and Domestic Resource Cost (DRC). ‡ Essentially the three following aspects are covered: ‡ Economic Rate of Return (ERR).

‡ The tradable inputs and outputs are valued at their international prices and the non tradable inputs and outputs are revalued at fixed conversion factors. ‡ Labour is revalued at the shadow wage rate.SCBA Economic Rate of Return (ERR): This is the rate of return the project will earn if there are no distortions. ‡ The flows of costs and receipts are revalued at their opportunity costs. 01/01/2010 415 .

‡ The ERP measures the margin of protection on value added in the production process rather than on the product price. the ERR should be at least 12% and should be more than the prevailing rate of return. According the Planning Commission. 01/01/2010 416 .SCBA ‡ The flow of net receipts is then discounted to find the ERR. Effective Rate of Protection (ERP): This indicates the degree of effective protection that a product enjoys through its production cycle.

01/01/2010 417 .SCBA ‡ It is defined as the excess percentage of domestic value added due to the imposition of tariffs and other protective measures on the product and its inputs over foreign or world market value added. ‡ Tariffs and subsidies provide protection to domestic processing activities by raising the value added obtainable by a firm or industry.

SCBA ‡ Protection permits domestic industries to operate with a value added higher than that under free trade. 01/01/2010 418 . ‡ The higher the ERP. the greater is this inducement. leading to economic utilisation of scarce resources. thereby providing incentives for the movement of scarce domestic resources into protected industries.

as it refers to the real opportunity cost in terms of domestic resources.SCBA Domestic Resource Cost: This is the most crucial indicator of the viability of a project especially from a macro-perspective. 01/01/2010 419 . ‡ It is an indicator of the comparative advantage in any product. ‡ It is useful in deciding whether a product should be imported or domestically produced.

the total cost of the project is divided into two categories: rupee and foreign exchange expenditure. 01/01/2010 420 . Sales are revalued at world prices. ‡ The cost components included are: total operating cost of the normal year. ‡ Taxes are excluded as they are transfer payments. 8% depreciation on fixed capital and a 10% return on capital employed.SCBA ‡ For the purpose of calculations.

The DRC is compared with the exchange rate. 01/01/2010 421 . Limitations of SCBA: ‡ Because of the nature of the social costs and benefits there cannot be any standard method or technique applicable to all types of investments.SCBA ‡ The rupee expenditure and foreign exchange saved/earned are calculated. ‡ A DRC lower than the exchange rate indicates that the product could be profitably manufactured locally.

SCBA ‡ Every project will require a different approach while identifying and measuring its social benefits and costs. ‡ Further many of the costs and benefits are intangible and so their valuation in terms of money is bound to be subjective due to the biases and prejudices of the analyst. 01/01/2010 422 . ‡ However the element of subjectivity can be reduced by cross checks. the costs would be prohibitive. ‡ If all possible alternative assessments are sought to be socially assessed.

the gains of the social evaluation of investments cannot be disregarded.SCBA ‡ In conclusion. 01/01/2010 423 . in spite of the limitations. ‡ Probably in due course of time. the social scientists will improve the methods of assessment used ion SCBA. ‡ An awareness of the SCBA will enhance the contribution of the entrepreneurs to the society at large.

it is a document that contains the representation of the strategy of the firm in monetary terms. ‡ In other words. 01/01/2010 424 . carryout and control the operations of business. It is a statement showing how a firm would allocate its resources during a given time period. It shows the resource constraints on various activities of the firm. ‡ A budget is a plan of spending.Budget ‡ Budgetary control is a tool of management used to plan.8.

‡ Budget plan and control gives a firm basis for participative management. ‡ Budget plan and control is closely related to accounting. 01/01/2010 425 .Budget ‡ The concepts and procedures under budget plan and control have wide application not only in profit oriented enterprises but in every enterprise where the resources are limited and have to be properly applied. It also supplies info for marginal and standard costing and flexible budgets.

Thus it creates involvement and commitment.Budget ‡ It requires the involvement of all management levels in the planning process and in the approaches for accomplishing the goals. ‡ First step is to forecast future targets. determine resources and cash flows. ‡ The process of preparing the budget plan consists of finalising the functional objectives and then preparing the master budget. ‡ It enlightens the members of the management team regarding the objectives of the enterprise and its approaches. resolve the conflicts of sales. 01/01/2010 426 .production-inventory problems.

‡ It covers all the operations in the enterprise and involves a total systems approach. ‡ Total Systems Approach: ‡ A comprehensive budget plan and control encompasses much more than a periodic financial budget. 01/01/2010 427 .Budget ‡ The effectiveness of budget control will be enhanced if the organisation is divided into sub-units as decision centres or responsibility centres. ‡ A single high-ranking official or a committee of members should be entrusted with the responsibility of receiving and reviewing budgets from the sub-units. and consolidating them into a master budget and its periodical revision.

‡ The position and forecast for the economy in general and the industry in particular. should be factored into the making the strategic long term budgets and within the overall long term budgets. 01/01/2010 428 . short term budgets should also be prepared. ‡ Budgeting the performance and requirements of each section and then using these budgets as targets for controlling the sections and measuring their performance.Budget ‡ The budget so prepared should be in line with the overall comprehensive objectives of the enterprise. ‡ What are the objectives of a budget? ‡ Entrusting the individual planner at all levels with the budget responsibilities.

Budget ‡ Supervisors of each section should have the responsibility for the output. . This calls for a constant comparison of the actual with the budgeted results. quality and cost. income and expenditure which deals with departmental budgets framed on the basis of policy requirements and the responsibilities of supervisors. ‡ Budgetary control: Is a plan of operation based on a forecast of sale . ‡ Budgetary control . also considered as a profit plan has become a means of effective 01/01/2010 429 management control.

Budget ‡ Budgets can be broadly classified as : ‡ Revenue and expense budgets: ‡ Time. and manpower budgets. ‡ Capital expenditure budgets. space. ‡ Master operating budgets. 01/01/2010 430 . ‡ Cash budgets. materials.

Budget f o r d ir e c t la b o u r h o u rs . 2. m a c h in e h o u rs . d ir e c t la b o u r . M a t e r ia ls and M anpow er B u d g e ts 1. Space. . T h e y g iv e a fo re c a s t of cash r e c e ip t s and expenses. m a t e r ia ls e tc . 1 .O p e r a t i ng expense b u d g e ts d e a l it e m s of expenses e . 2 . B u d g e ts o f u n it s of m a t e r ia ls .F in a n c ia l p la n f o r in it ia l c a p ita l e x p e n d it u r e. f ir s t in a fo re c a s t in c o m e s ta te m e n t a n d t h e n in a fo re c a s t b a la n c e 431 s h e e t.g . T h e s e a re t ie d in w it h lo n g . u n it s p ro d u c e d C a p it a l E x p e n d it u r e B u d g e ts Cash B u d g e ts 1 .t e r m b u s in e s s p la n n in g . 2.T y p e s o f B u d g e ts R evenue and Expense B u d g e ts T im e . M ast er O per a t in g Budg e ts 01/01/2010 A m a s te r o p e r a t in g budget g a th e rs to g e th e r d a ta fro m th e s e v e ra l d e p a rtm e n t s and s u m m a r is e s t h e m . S a le s b u d g e t is th e f o u n d a t io n of b u d g e ta r y c o n t r o l. Cash b u d g e t is th e m o s t im p o r t a n t s in g le c o n tro l o f a b u s in e s s . F in a n c ia l p la n f o r g ro w th o r e x p a n s io n .

‡ It helps in coordinating the activities of an enterprise. ‡ It aids in measuring performance. ‡ It keeps expenditure in check. ‡ It provides an effective means by which. ‡ It helps in determining the policies of an enterprise. the entrepreneur can delegate authority without sacrificing his overall control.Budget ‡ Advantages of Budgetary control are: ‡ It helps the process of panning. 01/01/2010 432 .

 comparing the performance with the Budget.  correcting the unfavourable variance for better growth. 01/01/2010 433 .  measuring the results.  publishing the budget. ‡ The steps involved in Budgetary control are: Preparation of the Budget. ‡ Budgeting/planning is a technique of organizing.Budget ‡ It promotes cooperation and enhances controls on business activities. developing and controlling business activity in a systematic manner.

professional management talent is missing. and the absence of the reliable MIS. the tendency to follow the age-old methods of dealing with matters.Budget ‡ Surprisingly many business do not have planning because: ‡ The uncertainties in the ever changing economic environment make the planning (with assumptions) meaningless. ‡ In fact these are the very reasons why a systematic planning should be in place. 01/01/2010 434 .

: l t t it l ti t t t it r r t ti lli i tri ri t t f r t r t t t t r t l t (i & t) ti ti l t t i r t ri rt / l i i i tr ti t t l l ri rf r t r t t i ll 01/01/2010 435 .t r tr l t i r t r ti r r t t ti .

‡ Budgets for the projects are prepared for one another reason also : to arrive at the proper pricing of the product.Budget ‡ When using budget for control. comparisons should be made between the expenditures that should have been made and actually made and not between what was allocated and actually spent. ‡ This comparison would bring out the real efficiency of the project. 01/01/2010 436 .

± cost of the project is estimated without using any engineering data. .arrived at using the past experience the output figure may be as low as 35 of actual costs-) 01/01/2010 437 . The estimating process can be classified in two ways: ‡ one is based on the amount of input info required and the accuracy: ‡ four types of estimates : ‡ Order of magnitude analysis (used when the project is in the conceptual stage.Budget ‡ There are different types of approaches to make budgets or estimates of costs.

well laid out plans.Budget ‡ approximate estimate (also without any engineering data .made by interpolating the expenditure on similar projects undertaken earlier by making adjustments to price levels ± this estimate is found to vary with the actual by about 15%) ‡ Definitive estimates (are more accurate based on detailed engineering data. estimation manuals have to be 01/01/2010 prepared ««« 438 first . (in this method. clear specifications and reliable unit prices and may vary by a small 5% from actuals) ‡ and estimate using estimation manual.

Even if manuals exist. lunch breaks. 01/01/2010 439 .. They contain standard costs for various costs.Budget ‡ «. set up time etc. And are determined taking into account all factors such as machine down time. they have to be constantly updated) ‡ The other process is based on whether the estimate is made starting at the top or bottom of the work breakdown structure. clean up time. Thus this method can be used only for projects which are common with other projects based on which the manuals are developed.

‡ Such estimate is broken down into various individual tasks for all the levels upto the lowest. ‡ Here there is no atmosphere of trust. 01/01/2010 440 . The process may develop strains in the relationships with the staff at lower levels. ‡ Moreover the senior level staff do not want to share the power of decision making with the juniors. the assumption is that the people at the lower level tend to overstate the resources as well as the time required to complete the project. ‡ In this method. first the resources to be allocated for the project as a whole is estimated.Budget ‡ In the top-down method.

only the essential activities will be funded ‡ The other method. ‡ All such estimates at all levels are aggregated to arrive at the total direct cost of 01/01/2010 441 the project. . ‡ The estimation starts at the smallest work element at the lowest level. the bottom-up budgeting is the reverse in the approach to the topdown approach.Budget ‡ The advantage in this method is that since the total budget is fixed by the top management. ‡ Estimates of machine hours and man hours are then converted into rupees.

‡ The advantage of this method is the high level of accuracy that can be achieved. ‡ The disadvantage is the fact that on the expectation of pruning down by the seniors before finalisation.Budget ‡ Then the general and administrative overheads are added . 01/01/2010 442 . the juniors are most likely to inflate the estimates. ‡ Since the estimates are made by all level of employees they would be fully committed to the success of the project. some margin for contingencies and profit.

have to be made.Ideally the estimates are based on similar tasks done earlier. ‡ But the tasks in different projects may not be the same and moreover it will be difficult to predict the level of prices after the lapse of a few months or years. and a total cost analysis is made.after aggregating all the costs and other resources needed for the whole project. equipment and people. the task of allocation of the resources ± money. ‡ 2.Budget ‡ The Budgeting Process: ‡ 1. 01/01/2010 443 .

Subsequent meetings may be required for further deliberations or clarifications but only the departmental managers are called and they would be expected to coordinate the project activities of their departments with 01/01/2010 project office. ‡ In the meeting.The Kick-off meeting: A meeting of all the people who are involved in the process of budget making from all the departments is called. 444 the . the WBS is discussed so that every body understands the roles and responsibilities assigned ± which is essential for achieving consistent and reliable estimates.Budget ‡ 3. ‡ 4.

Underestimates in the case of an in-house project may be managed by increasing the price of the end product. ‡ 6. And then converts into rupees by applying the appropriate wage rates. ‡ The project office consolidates all the requirements to arrive at the total figure. but underestimates while submitting tender documents will result in loss to the firm. 01/01/2010 445 .Budget ‡ 5. Estimation of labour requirements: All the line departments estimate the labour requirements for each task assigned to them in man hours.

‡ 7. from the revenue that would be generated by the user department as there may be lean periods of revenue generation some time. It would be unwise to allocate resources to the R D dept. 01/01/2010 446 . Estimation of overheads: Control of both the direct costs as well as the indirect costs viz. overheads is important.Budget ‡ It is a difficult exercise to predict the wage levels for the future and therefore suitable escalations have to be in built. ‡ Normally overheads of a project are more than the direct costs .

‡ The description of the materials required. expected cost. are estimated 01/01/2010 447 to be 3 to 5 % of the total direct cost. Estimation of materials and support services: The quantities are estimated as per the engineering standards.Budget ‡ 8. . name of the supplier. ‡ Estimates of expenses for support activities like expenses to be incurred on travelling. transportation of materials etc. duration of shelf life and the estimated scrap value are all the details that are passed on to the project office by all the departments.

The margin of profit depends on whether the firm is interested in getting the contract for strategic reasons or for profit. Pricing the project: From the estimates of the different types of costs mentioned earlier. the cost of the total project is arrived at. If the project is internal to the firm. Price from the strategic angle will be low.Budget 9. Further it also depends on the stance of the competitors ± whether they are also interested in the project for strategic reasons or for profit? 01/01/2010 448 . then the total cost of the project arrived at will be the project budget. then the margin of profit has to be added to the total cost and quoted to the client as the price. But if the project is to be executed for an outside client.

‡ If the project is for commercial considerations.Budget ‡ Some firms quote prices even at a loss in order to capture the contract viewing them as investments to capture more and more future contracts. then adequate profit margin has to be added. income from servicing or getting into a new line etc. ‡ If there is going to be a long time gap between quoting and executing the project appropriate cost escalation clauses have to be incorporated. 01/01/2010 449 .

‡ The usual pitfalls in pricing are : ‡ Not defining the scope of the project properly. ‡ Statement of work lacking clarity resulting in misinterpretations. 01/01/2010 450 . ‡ the funding agencies may also think on similar lines and reject the funding proposals. ‡ Inaccuracies in the WBS. ‡ Over optimistic project schedules resulting in spending more on manpower than required.Budget ‡ A very low quotation also has its disadvantages : ‡ the client may suspect the ability of the firm or the output quality or the time required.

‡ 10. Budgeting system 01/01/2010 451 . the projects are reviewed sometimes resulting in scrapping of the project altogether ± this demoralises the people working on the project) ‡ and Planning. Budgeting techniques: Two techniques which were used earlier and not so popular are : ‡ Zero Based Budgeting (ZBB) (Every time funds are to be released. and ‡ Use of inappropriate techniques for estimates. Programming.Budget ‡ Mismatch in the skills required and actually assigned. ‡ Inadequate provisions for contingencies and cost escalations. .

‡ This is a grave mistake as can be explained with the example of a cement plant. ‡ Whereas a plant based on the dry process would cost high initially for commissioning but further maintenance costs would be much lower.Budget ‡ Life Cycle Costing: Earlier. ‡ A sponsor may choose to put up a plant based on the wet process since it is cheaper for commissioning but the further maintenance costs would be high. the approach of the project sponsors or entrepreneurs was to take into account all the expenditures needed to implement the project and start commercial production and look no further beyond that point. 01/01/2010 452 .

453 . choices made are evaluated against the total life cycle costs of the system. ‡ This system takes into account the cost of R D. operating and maintenance costs. ‡ This is what Life cycle costing system about. In this system.Budget ‡ Considering the life time of the project. it would be sensible to opt for a plant with the dry process. production costs. ‡ Costs under these heads are calculated for each of the short listed projects and then 01/01/2010 decision is taken based on the aggregates. construction costs and phase out costs.

‡ The entire exercise has to be repeated whenever the requirements undergo a change.Budget ‡ This system has got its defects too: ‡ Life cycle costing system is expensive and so suitable only for large projects. 01/01/2010 454 . ‡ and it assumes that the life of the products is finite and is known.

ten times the original estimate). and product development depts.Project Cash Flows ‡ Estimates of cash flows are a key element in any investment and is one of the most difficult steps in budget making. ‡ This exercise involves many variables and different people participate in it: ‡ Capital outlays by the Engg.e.. 01/01/2010 455 . ‡ The example of the Alaska Oil pipeline would do to show how crucial is it in the process ±the pipeline which was estimated to cost $700 mn finally ended up in $7 bn. (i.

and ensure that the forecasts are based on a set of consistent economic assumptions. personnel executives.Project Cash Flows ‡ revenue projections by the marketing dept.. 456 01/01/2010 . and others. ‡ cost of raw materials and stores by the purchase dept.. ‡ and then there are cost accountants.. ‡ The role of the finance manager is very crucial in the process since he has to coordinate all the depts. ‡ the operating costs by the production dept.. with the focus on the relevant variables and as far as possible eliminate biases inherent in the process.

‡ For a conventional project they are : ‡ the initial outlay( after tax cash outlay on capital expenditure and the networking capital when the project is set up) ‡ then the operating cash flows (the after tax cash inflows resulting from the operations of the project during the economic life of the project) ‡ and the terminal cash flow (the after tax cash inflow due to the liquidation of the project at the end of its economic life) 01/01/2010 457 . the relevant cash flows are the incremental post-tax cash flows.Project Cash Flows ‡ 1.Elements of the Cash flow stream: ‡ For a project.

The earlier two criteria may still be valid but the market for the product may diminish or even disappear.) 01/01/2010 458 .Project Cash Flows ‡ Time Horizon for analysis: This is the minimum of the following : ‡ physical life of the plant ( period during which the project is physically usable condition) ‡ technological life of the plant (the period of time during which the technology would not become obsolete) ‡ product market life of the plant: (the period during which the product has a reasonably satisfactory market.

1000 and generates cash flow of 1200 at the end of one year i.Project Cash Flows ‡ Investment planning horizon of the firm: (for infrastructure projects. the life may extend even upto 30 years) ‡ 2. . ‡ Take the example of a firm investing an amount of Rs. 1000 will 01/01/2010 459 be financed by debt at the rate of 15% pa.(cash flows are -1000 and +1200). the rate of return is 20%.e. ‡ Suppose the entire amount of Rs. Basic principles of cash flow estimation: ‡ Separation principle: the cash flows out of the investment and financing should be separated.

‡ This is in the case of a running firm which starts a project. ‡ Incremental principle: The cash flow of the project must be measured in terms of incremental terms. 01/01/2010 460 .Project Cash Flows ‡ Then the cash flows associated with the financing are +1000 and -1150. implying the cost of capital of 15%. ‡ The return from the project should alone be taken into account while calculating the cash flows from the project. The interest outgo of 150 is taken as the cost of capital.

Project Cash Flows ‡ Project cash flow = (For an existing firm): cash flow for the year with the project ± cash flow for the year without the project. it may lead to wrong decisions to drop the project resulting in losing the market 01/01/2010 461 altogether). . ‡ While calculating the incremental cash flows. one should consider all incidental effects ± i.e. the cannibalisation effect has to be ignored (if considered. then if the market has no barriers and is full of competition. ‡ If the project results in product cannibalisation. the project may have been incidental to add more profit for the other activities of the firm or might have taken away the incomes of the project from the other activities.

Such sunk costs should be ignored.Project Cash Flows ‡ On the other hand if there are entry barriers and not much of competition. 462 into . the opportunity costs should be taken 01/01/2010 account. then the cannibalisation effect has to be considered. ‡ Include Opportunity costs: When a project uses the resources already available with the firm. the cost is already incurred and lost anyway irrespective of whether the project is accepted or not.20 lakhs for conducting preliminary studies for generating information about the project. ‡ Ignore sunk costs: Supposing that a firm spends a sum of Rs.

Project Cash Flows ‡ Question the allocation of overhead costs: What matters is the incremental overhead costs attributable to the project . Some other overheads of the firm allocated to the project for the purpose of sharing may be ignored. ‡ Estimate working capital properly: The outlays have to be considered properly . The working capital at the end of the project is assumed to have a salvage value equal to its book value 01/01/2010 463 .

additional. the marginal tax rate should be considered for estimating the tax liability of the project. 464 01/01/2010 .Project Cash Flows ‡ Post tax principle: ‡ Cash flows should be measured in post-tax terms.e. Since the income from the project is marginal i. ‡ Treatment of losses: ‡ The general principle is: ‡ If the firm incurs losses (whether the project alone makes profit or loss) : defer the tax savings till the firm makes profits. ‡ If the project loses but the firm makes profits: take tax savings in the year of loss.

‡ Effect of non-cash charges: In India as per the IT act. (Buildings5%.Project Cash Flows ‡ If both the firm and the project make profits: consider taxes in the year of profit and ‡ In the case of a standalone project: defer tax saving until the project makes profits. Vehicles on hire 40% Pollution control equipment 100%) 01/01/2010 465 . Computers60%. the admissible method of depreciation for corporate taxation purposes is the written down method. Plant and machinery15%.

Project Cash Flows ‡ Consistency principle: ‡ Cash flows and the discount rates applied to these cash flows should be consistent with respect to the investor group and inflation. . ‡ Cash flows to all the investors : (equity holders + lenders) ‡ = PBIT(1-tax rate) + non cash charges ±Capital expenditure ±change in the working capital ‡ If you consider the cash flows from the point of view of the equity investors alone then it changes to : ‡ The figure in the previous step ± preference dividend-repayment of debt +proceeds from debt issues-redemption of preference capital 01/01/2010 466 +proceeds from preference issues.

the cash flow to all investors is considered and hence the weighted average cost of capital is applied. ‡ Inflation: When the cash flows are in nominal terms. ‡ Generally. 01/01/2010 467 . generally nominal cash flows are used and hence nominal discount rates should be used. ‡ However.Project Cash Flows ‡ The discount rate applied for cash flow to all investors is the weighted average cost of capital and for cash flow to equity is the cost of equity. the discount rate is also nominal and if it is real cash flow then real discount rate.

10 onwards. . ‡ Viewing a project from different perspectives: ‡ A project can be viewed from four distinct points of view and they are: ‡ Equity point of view. ‡ Long term funds point of view. (Total funds = Long term funds + current Liabilities) ‡ The cash flow components slightly differ from 01/01/2010 468 one another.Project Cash Flows ‡ Cash Flow Illustrations: See PC Pages 9. (Long term funds = equity + Long term debt) ‡ Explicit cost funds point of view: (Explicit cost funds = Long term funds + short term debt) and ‡ Total funds point of view.

Recovery of nwc.Net working Capital 3.Operating cash inflow ( 8 + 5) 13.Costs (other than dep.Net salvage value of fixed assets 10.2 and 9.Fixed Assets 2. the most common view is that of explicit cost funds. Net cash flows relating to explicit cost funds: Year 0 1.Depreciation 6. and interest) 5. Book value of investment 01/01/2010 Year1« 469 .Terminal cash inflow (9 + 10) 14.Revenues 4. 11. Examples involving this view: see exhibits 9.Initial outlay (1 + 2) 12.3 in PC.Profit after Tax 9.Profit before tax: 7.Tax 8.In capital budgeting. Net cash flow (11+12+ 13) 15.

Project Cash Flows ‡ = {.equity funds committed to project + (Profit after tax ± Preference dividend + depreciation +other non cash charges) + Net salvage value of fixed assets + Net salvage value of current assets ± repayment of term loans ±redemption of preference capital ± repayment of working capital advances ± retirement of trade credit and other dues. } 01/01/2010 470 .

Inte re s t o n te rm lo a n 7 .D e p re c ia tio n 5 .O p e ra ting C os ts (o the r tha n d e p .P ro fit be fo re ta x : 8 .6 in P C ) Year 0 1 . Inte re s t o n W C a d va nc e 6 .P ro fit a fte r T ax 1 0 . inte re s t) 4 .. R e tire m e nt o f tra d e c re d ito rs 1 7 .C a s h flo w s re la ting to e q uity:-C o ntrib utio ns m a d e a nd be ne fits re c e iva b le b y e q uity ho ld e rs .Initia l inve s tm e nt (1 ) 1 8 .N 01/01/2010 e t c as h flo w (1 7 + 18 + 1 9 ) 471 .O p e ra ting c a s h flo w s (9 -1 0 + 4 ) 1 9 .P re fe re nc e d ivid e nd 1 1 N e t s a lva ge va lue o f fixe d as s e ts 1 2 N e t s a lva ge va lue o f c urre nt a s s e ts 1 3 R e p a ym e nt o f te rm lo a ns 1 4 R e d e m ptio n o f p re fe re nc e c ap ita l Y e a r1 « a nd 1 5 R e p a ym e nt o f s ho rt te rm b a nk b o rro w ing s 1 6 .: (S e e e x a m p le in e x hib it 9 .E q uity fund s 2 .R e ve nue s 3 .L iq uid a tio n a nd re tire m e nt c a s h flo w s (1 1 + 1 2 -1 3-1 4 -1 5 -1 6) 2 0 .T a x 9 .

+ Other non cash charges + Int.Project Cash Flows ‡ Cash flows relating to Long term funds: (see example in exhibit 9. 01/01/2010 472 . on LT borrowings(1-t) ‡ + Net salvage value of fixed assets + Net recovery of working capital margin.7 in PC): ‡ = .(Fixed Assets + Working Capital Margin) ‡ + {PAT + Dep.

Interest on term loan 8.Net cash flow (13 + 14+15) 01/01/2010 473 .Depreciation 6.Fixed assets 2. Interest on WC advance 7. Operating costs 5.Working capital margin 3.Revenues 4.Profit after Tax 11Net salvage value of fixed assets 12Net recovery of WC margin 13Initial investment (=1+2) 14Operating cash inflow = (10+5) +7(1-t) 15Terminal cash flow =11 + 12 16.Tax 10.Year 0 Year1« 1.Profit before tax: 9.

01/01/2010 474 .Project Cash Flows ‡ Cash flows relating to total funds: (See example in exhibit 9.e.+ other non cash charges + Int. on LT borrowings (1-tax rate) + int. on ST borrowings (1-tax rate) ‡ + Net salvage value of fixed assets + net salvage value of current assets.Initial investment (i. fixed assets + current assets) ‡ + PAT + dep.8 in PC) ‡ .

perating costs . otal funds . ax .ea r . et salvage value of fixed assets . et salvage value of current assets . perating cash inflow ( ) 6( -t) . Interest on advance 6. rofit after ax . epreciation .Initial investment ( ) . erminal cash flow . evenues .Interest on term loan . rofit efore tax: . et cash flow ( 01/01/2010 ear ( -t) ) 475 .

The three components of the cash flow stream for a replacement project are defined as follows: 01/01/2010 476 . estimating the relevant cash flows for a replacement project is somewhat complicated because the incremental cash outflows and inflows in relation to the existing project have to be determined.4 in PC) ‡ Unlike the case of new or expansion projects.Project Cash Flows ‡ Cash flows for a replacement project: (See example in 9.

Net Cash Flow = (1) + (2) + .(Cost of the (3) new assets + (1) : .Initial Investment : Net working capital required for the new asset) - (After tax salvage value realised from the old asset + Net working capital required for the old asset) Operating cash inflows from the old asset had it not been replaced (After tax salvage value of the old asset. had it not been 477 replaced + Recovery of net (2): + inflows: Operating cash + Operating cash inflows from the new asset + After tax salvage value of the new asset + Recovery of net working capital associated with (3): + Terminal cash flow : 01/01/2010 .

. . et terminal value of old machine .increase in nwc . on old machine . on new machine . ep. ep. otal erminal cash inflow =11-12 I : et cash flow ( 10 14) 01/01/2010 ear 13 478 . 6. et operating cash inflow= III: erminal cash inflow: . ax savings on incremental dep. x . otal net investment -( ) II: perating inflows over the life of the project: . After tax savings in manufacturing cost 6. alvage value of old asset .ear I: Investment outlay: . et terminal value of new machine . ost of new asset .Incremental dep. ecovery of incremental nwc.

Project Cash Flows ‡ How Financial institutions and Planning Commission define cash flows: ‡ Financial institutions: ‡ Cash outflow: = Capital expenditure on the project (net of interest during construction) + Outlays on working capital 01/01/2010 479 .

01/01/2010 480 . land at 100% and other capital assets at 5% on initial cost).e.Project Cash Flows ‡ Cash inflow: = Operating Inflow (i. on lease rental ) + Terminal Inflow ( i.e. PAT + Dep.e. + int. Recovery of wc at book value + residual value of capital assets i.

01/01/2010 481 . life of the project would be 12 years in general and may be shorter depending upon the rate of technological obsolescence. ‡ There are some minor differences between the way the financial institutions define and we have defined the cash flows from the total funds point of view. the max.Project Cash Flows ‡ For IRR purposes.

Recovery of WC at book value +Residual value of capital assets (LAND AT 100% AND CAPITAL ASSETS AT 5% OF INITIAL COST) Cash flow defined fro the total funds point of view Sa e as in Financial institutions PAT + Dep. + INTEREST (1-T) Recovery of WC at book value +EXPECTED NET SALVAGE VALUE OF OTHER ASSETS 01/01/2010 482 .Initial invest ent Operating cash flow Ter inal Cash Inflow Cash flow strea defined by the financial institutions Capital expenditure on the project (net of interest during construction period) + outlay on working capital PAT + Dep. + INTEREST..

(Any replacement expenditure incurred during the life of the project should be allowed in the year of occurrence) 01/01/2010 483 .Project Cash Flows ‡ Planning Commission: ‡ The ³Manual for preparation of feasibility reports´ developed by the Planning Commission has prescribed certain rules in this regard. ‡ Interest during construction period should not be allowed for in the year wise capital expenditure figures since it is implicitly taken into account by the discounting procedure.

01/01/2010 484 . ‡ Depreciation and financial charges on capital expenditures covered by the capital cost figures should not be deducted in defining returns.Project Cash Flows ‡ Returns should be defined on a gross basis as operating revenues minus operating costs. ‡ They are allowed for implicitly in the discounting procedure.

01/01/2010 485 . the operating cost estimates must include interest payments on funds borrowed for working capital. an IRR on own funds may need to be presented. which are assumed to be borrowed.Project Cash Flows ‡ Capital cost estimates generally do not allow for funds required for wc purposes. but only for the margin on wc. ‡ In this case. ‡ In some cases involving the use of fixed interest term loans for capital expenditure.

the initial capital cost figures should cover only the expenditures out of equity capital.Project Cash Flows ‡ In such cases. ‡ Repayment of term loans and interest due on them should be allowed for in the subsequent years as and when they are expected to arise. ‡ The returns should allow for a salvage value of assets at the end of the period. ‡ Costs and returns should be calculated over the entire life of the project or over 25 years whichever is less. 01/01/2010 486 .

‡ A fairly long planning horizon is envisaged. have a long economic life.Project Cash Flows ‡ So the following observations are in order: ‡ A project may be viewed from the point of view of equity capital or long term funds. in general . This perhaps reflects the fact that the projects considered by the Planning Commission. ‡ Cost and return streams have been defined consistently with the point of view adopted. 01/01/2010 487 . Further they are defined in pre-tax terms.

taking credit for positive results and attributing failures to other causes).Project Cash Flows ‡ Biases in Cash Flow estimation: ‡ Overstatement of profitability: ‡ Native optimism (overestimates of themselves). ‡ anchoring (holding on to their beliefs even if contrary evidences are available) ‡ Myopic euphoria ( Each person¶s favourable opinion is reinforced by the opinions of others in the group). Attribution error (wrong perceiving of the causes of events. 01/01/2010 488 .

‡ Stretch targets ( Managements set stretch targets for motivating their employees.Project Cash Flows ‡ Competitor neglect (neglecting the capabilities of the competitors in similar lines of business). Nobody likes to listen to pessimistic news even if true) 01/01/2010 489 . ‡ Organisational pressure (every sponsor exaggerating the benefits of his project to get accommodation within the budget of the organisation).

‡ For taking an µoutside view¶ Daniel Kaheman and Amos Tversky suggest the five step procedure: Select a reference class. Assess the reliability of your prediction and Correct the intuitive estimate. Management should look at the results of similar outside projects to arrive at reasonably optimistic targets. Intuitively predict your project¶s position in the distribution.Project Cash Flows ‡ Tempering the optimism: ‡ Too much of optimism is bad. Assess the distribution of outcomes. 01/01/2010 490 .

01/01/2010 491 . Aggressive goals may motivate the people but outside view forecasts should be used to decide whether or not to make a commitment in the first place.Project Cash Flows ‡ Putting optimism in place: Daniel«. ‡ Understatement of profitability: ‡ The opposite kind of bias can occur while forecasting the terminal cash flows and may understate the profitability and due to this some of the projects which can otherwise be accepted may be rejected. says that there needs to be a balance between optimism and realism ± between goals and forecasts.

‡ and Value of future options is overlooked (new investment opportunities are opened up through this project). 01/01/2010 492 . (the project may establish a market position. and build brand loyalty). enhance distribution network. defining the salvage value of the assets at 5% of the initial cost: This may happen due to : ‡ underestimating the salvage value (actual wear and tear is much less than the depreciation provided) . ‡ ignoring intangible benefits. create an R D capability .Project Cash Flows ‡ For example.

used judiciously during the execution of the project and the waste if any have to be disposed efficiently. stored safely in a proper place . ‡ Here are some µright¶ parameters about the material required for the project: right price.9.««« 01/01/2010 493 .Materials Management in Project Planning-Procurement. storage and disposal ‡ Different varieties of quality materials have to be procured in adequate quantities at the right price. right quality and right technology.

right ethical standards. right source. right transportation.´ 01/01/2010 494 .. right legal contracts.right engineering parameters. ‡ According the PMBOK: ³Project procurement Management is a process of acquiring goods and services from a firm external to the performing organisation. right handling methods. right lead time. right place of delivery. right insurance. right quantity.Procurement Planning ‡ ««. right packaging.

Procurement Planning ‡ There are seven key components in a project procurement management system :1. 6. 5. 3. ‡ 1.project procurement planning.contracting.contract administration and 7. 2. 01/01/2010 495 .solicitation planning. 4.solicitation.source selection. Project procurement planning: It is the process of discovering the needs of the project that can be satisfied by acquiring products and services from firms external to the project organisation.contract closing.

Product or service description/ PBS.. 01/01/2010 496 . ‡ The organisation may have policies to procure all materials from a single or multiple suppliers.Procurement Planning ‡ It involves the questions: What to procure and then how and when? ‡ Centralised procurement process has its advantages of cost savings. procurement sources. some documents relating to the project would exist and they can be taken as guide: ‡ They are Scope statement. make or buy analysis. market conditions. ‡ Before this process begins.

Procurement Planning ‡ The project manager usually resorts to the CPM and PERT techniques to estimate the timings of the products or services to be procured. ‡ The product or service description provides information pertaining to the technical specifications of the products which are to be kept in mind while procuring. 01/01/2010 497 . ‡ So defining the needs of the project is the most crucial task of the Project manager.

01/01/2010 498 . Usually product or service specifications are written or graphical representations consisting of:  Design specifications (the physical characteristics of the product). it must be elaborate enough to support the latter stages of project planning.Procurement Planning ‡ Though the content and format of a product or service description statement vary from product to product and from project to project.

needed to procure the products and services from the market as per the specifications given in the product. Procurement resources: Description of the resources ±systems and personnel.Procurement Planning performance specifications ( the required operational capabilities of the end product) and functional specifications (part of the performance specifications and identified only when the vendor mentions the utility of the product or service). 01/01/2010 499 .

ordering costs and the WBS etc. interest rates .Procurement Planning ‡ If the project is complex. Market conditions: The purchase manager should be well conversant with the market ± products available in the market. 01/01/2010 500 . then the presence of a specialised procurement team is necessary so as to properly communicate to the suppliers of the critical supplies and procure them at the right time. terms of the vendors. inflation rates.

But if that is not possible. and savings on costs. he has to decide whether to procure them from within the organisation or from outside.Procurement Planning Make or buy analysis: When the Project Manager is armed with the required info on the required product and the market conditions. 01/01/2010 501 . it is better to procure the material from the appropriate vendors. delivery schedule. Making the product/s within the organisation has its advantages of control on quality.

transportation cost etc.).Procurement Planning Such µMake or Buy¶ decisions should be taken after considering the direct as well as indirect costs (ordering cost. the organisation¶s point of view and also the timeliness of the needs of the project. 01/01/2010 502 .

Unreliable suppliers. Inadequate capacity in own manufacturing.Reasons for Making: 1. and 4. Easy availability of standardised materials . 5. Ensuring alternate sources of supply. 3. 3. 4. Lower Production Costs. Reduction of inventory costs (JIT). Utilisation of surplus labour capacity. 2. Assurance of supply of adequate quantity. Quality Control and 1. Protection of special design or quality (Copyrights/Patents) Reasons for buying: 1. 2.

. or by the consulting firms or by the professional. Expert judgement: Analysis of the procurement process can be done by the specialists if available in the firm.Procurement«. technical associations conversant with the products.

‡ The contracts that the project manager would enter with the vendor may be of different types such as : ‡ Fixed Price (FP) contracts: . . at he same time expecting good performance.the vendor has to absorb any losses or profits due to subsequent increase or decrease in prices.the price is negotiated by the vendor and the project manager and agreed upon a fixed price.Selection of vendors ‡ In the process of selection of the vendor. 01/01/2010 505 . the vendor and the project manager try to pass on the risks to the other.

the project bears all the costs of the product or service and the vendor is paid a fixed fee for supplying the goods.--the process may be time consuming since the vendor may take more time to assess the risks over the contract period to arrive at the price profitable to him.the vendor may even inflate the price in anticipation of future increase in costs. 01/01/2010 506 .Selection of vendors . ‡ Cost plus Fixed Fee (CPFF) or cost plus percentage fee: In this type of contract. .

Selection of vendors ‡ --In this type of contract. where the owner of the plot bears the costs of all materials and the labour and the vendor is paid a percentage of commission). (example is a building contract. there is no reward for the vendor if time and cost are saved. the risk is with the project manager and not the vendor. --the project manager is not assured of the final cost.. ‡ Guaranteed maximum and shared savings (GMSS) contracts: 01/01/2010 507 .

Selection of vendors --The vendor is not selected by tender and has to complete the contract within the µguaranteed maximum¶ amount. µmaximum¶ minus the actual cost) is shared by the vendor and the project. it is for the vendor to make up and the savings if any.e. (i. --If the cost exceeds this µguaranteed maximum¶. 01/01/2010 508 .

the cost to the project is limited by a definite amount.Selection of vendors --In this type. 01/01/2010 509 . --Price negotiation has to be done carefully in order to avoid the inflation of the µguaranteed maximum¶ amount. then the saving is shared by the project and the vendor. ‡ Fixed price incentive fee (FPIF) contracts´: --This is similar to the FP with the difference that if the vendor is able to minimise the costs.

--Usually organisations handling R D type of projects enter into these types of contracts and the vendors are the maximum risk takers.Selection of vendors ‡ Cost plus incentive fee (CPIF) : --This is similar to the CPFF except for the flexibility of altering the fee based on a formula which compares the total project costs with target costs. 01/01/2010 510 .

Selection of vendors ‡ It is necessary for the top management and the project manager to plan procurement management very carefully and prepare the procurement management plan and statement of the work. h nature and technical risk involved. h evaluating the price of the product or service. ‡ The factors influencing the selection of the contract method are : hDegree of risk involved in terms of cost and time. h degree of competitive dynamics in pricing.«« 01/01/2010 511 .

and his financial management system h consistency of the vendor¶s commitment to the project. h the vendor¶s risk absorption capacity. ‡ The Procurement Management Plan: Is the document detailing how the processes would be managed from solicitation planning till closing the contracts: 01/01/2010 512 .Selection of vendors ««h level of exigency of the requirement.

‡ Statement of work: A detailed. precise and transparent description of the product or service to be procured for the vendor to decide on his capabilities to take up the assignment. combining the procurement activities with scheduling etc. 01/01/2010 513 . the persons in charge for developing the estimates for evaluation purposes. managing multiple vendors.Selection of vendors ‡ the type of contracts.

‡ The statement may be periodically revised by rephrased depending on the ongoing interactions with the vendor. 01/01/2010 514 .Selection of vendors ‡ The details will vary depending upon the nature of the product or service of type of contract. ‡ Procurement Document: This is a document that is used to invite proposals from the eligible vendors.

Selection of vendors ‡ Generally the words bid and quotation are used when the product or service to be procured is price sensitive and much sophisticated. ‡ The word proposal is used when non financial aspects like technical skills is in focus and is used while inviting architects and consultants. 01/01/2010 515 .

Selection of vendors ‡ A typical RFP cover many topics such as: A brief overview of the project. mode of supply of products/services. product specifications. accurate and complete information from the vendor. insurance of the product/services. 01/01/2010 516 . mode and time of payment. names of the key people with authority and responsibility to take decisions etc. ‡ The format should be designed in such a way that it elicits in-depth.

Selection of vendors ‡ Criteria for judging the vendor: Some of the factors are: hTotal cost of procurement. bids. This involves: 01/01/2010 517 . ‡ Solicitation: The next stage is solicitation. h management style. h technical expertise. offers or proposals from all the prospective vendors. h vendor¶s capacity to deliver at lowest cost. It is the process of obtaining quotations. and h financial position.

visiting their sites. enquiring from their bankers etc. 01/01/2010 518 . then meeting with customers of the vendors.  meetings with the vendors: These meeting precede the proposals from the vendors and are used to eliminate all the communication gaps regarding the needs of the project and prepare the ground for further negotiations. If not readily available from sources like associations.Selection of vendors  short-listing the vendors : The list should contain all the info about their expertise in different functional areas.

When consensus is arrived at on all the relevant issues.Selection of vendors The negotiating team may comprise of experts from all the relevant functional departments. both the sides sign the written contract incorporating the terms and conditions. 01/01/2010 519 .

Advantage of advertising is that a data base of potential vendors can be created from the responses received for the advertisement. 01/01/2010 520 . There is no negotiation of price and the lowest bid is usually accepted. For the projects involving the government. advertising in mass media is mandatory.Selection of vendors Advertising: This is a tool used by the project organisation to invite proposals from vendors through sealed bids.

Selection of vendors ‡ Vendor Selection: This is the process of receiving proposals from prospective vendors and evaluating these proposals to choose the right vendor. The proposals are classified into technical and commercial and both are evaluated separately in each and every proposal. The tools used for selecting a vendor are: 01/01/2010 521 .

‡ The topics to be covered in the contract are: price of procurement. technical approach. ‡ The contract may be in the form of a MOU in the case of highly complex and technical products. terms and conditions. legal bindings etc. management style. before signing it. 01/01/2010 522 .Selection of vendors ‡ Contract negotiation: ‡ Is a process aimed at enhancing the clarity and ensuring mutual consensus on the structural and procurement aspects mentioned in the contract.

‡ Screening system: Is a process of establishing basic performance standards for qualifying the proposals and the vendors have to qualify in the performance specification test developed by 01/01/2010 the screening system. ‡ It involves identifying and scoring all the significant activities from the proposal. 523 .Selection of vendors ‡ Weighing system: Is a process in which all the info pertaining to the qualitative aspects of the vendor is quantified. setting up a range for qualifying them based on the significance level and weighing them against the total scores.

‡ Any gap between the vendor¶s and vendee¶s price estimates indicates that the data in the statement of work is insufficient or the vendor failed to correctly interpret the statement of work. ‡ The project organisation develops its own estimations of product pricing. 01/01/2010 524 .Selection of vendors ‡ Developing independent estimates: This process is aimed at checking the authenticity of the price quoted by the vendor.

The project organisation is also responsible for paying the vendor the agreed price on the successful completion of delivery. ‡ Contracting: After selecting the vendors and evaluating their quality thoroughly. 01/01/2010 525 . the project organisation has to sign contracts with the vendors to bind them legally to deliver the specified product.Contracting«.

‡ vendor¶s warranty/guarantee for the product. ‡ terms and conditions of closing the contract and consequences for deviating from the agreement like late delivery etc. vendee. ‡ the type of contract being administered and the mode of payment. ‡ In general. the contract should contain: the definitions of ‡ vendor.Contracting«. 01/01/2010 526 . ‡ the process of change requisition and its approval. ‡ responsibilities of the vendor and vendee.

Reduces Paper Transactions.) ‡ 2) Stockless Purchasing (Arrangement in which a supplier holds the items ordered by the customer in its own warehouse. Involves standardized Data Transmittal Format through Computers. and releases them as and when required by the customer) ‡ 3) Just in Time Purchasing (JIT originated in Japan & is generally associated with the Toyota motor company . excess inventory and delay such that items only move through the production system as and when they are needed) .JIT purchasing is directed towards the reduction of waste i.How to order materials? ‡ 1) Electronic Ordering (Transactions Between Firms via Electronic Data Interchange ±EDI.e. Speeds Up The Procurement Time.

.Points to be kept in mind. By the Project Manager while procuring materials: ‡ Price Volatility ‡ Timely Availability ‡ Limited Storage Space .

Contract administration ‡ Contract Administration: according to PMBOK. ‡ If there are many vendors. ‡ In short. Contract Administration is the process of making sure that the vendor¶s performance satisfies the project needs mentioned in the contract. 01/01/2010 529 . contract administration is about applying the project management practices to the vendor-vendee relationship integrating the results of these practices back into the project. then they should all be handled.

 Progress reporting : to check the vendor¶s performance in terms of cost. time and technical aspects.Contract administration ‡ The project management practices that are built into the contract are :  Project planning and implementation ± to check whether the vendor is progressing as per the schedule.  Quality management : to check and constantly monitor the quality of the product being produced. 01/01/2010 530 .

 Financial management : to ensure timely and periodic payments as agreed to in the contract. ‡ It will be advisable for the project manager to appoint a µcontract administrator¶ to manage the total contract administration activities.Contract administration  Change management : to check the approval and implementation of potential changes and communicating the incorporated changes to the people requiring it. 01/01/2010 531 .

the duties of a contract administrator can be derived as follows:  Managing change.  Ensuring that the vendor understands specifications completely. 01/01/2010 532 .  Managing warranty on the products being produced.  Ensuring conformance to quality.  Managing the sub-contractors under the vendors.Contract administration ‡ So.

in process.  Handling deviations from the contract.  Resolving conflicts. ‡ Job status: The info collected during the project planning and implementation about the jobs entrusted to the vendors ± completed. their quality.Contract administration  Monitoring the manufacturing process. the expenditure incurred etc. gives the picture about the job status. 01/01/2010 533 .  Managing payment schedules and contract terminations.

‡ But any disagreement between the vendor and the project manager on accepting the change can lead to conflicts and claims and have to be resolved. ‡ Any performance of the vendor which is not upto the mark may also be taken as a change.Contract administration ‡ Requisition for change: Any changes to be made to the terms and conditions of the contract or to the product or service specifications are covered in the statement for change request. 01/01/2010 534 .

‡ Contract Closing: Is a process involving verification of the product along with updating all the project documents with the final results and storing all project info for future retrieval. 01/01/2010 535 . ‡ This process may also form part of the contract.Contract administration ‡ Vendor billing process: The vendor should submit the bills at periodic intervals as per the terms of the contract along with the supporting documents for payments by the project manager.

contract related audits and inspections««. changes requisitions. ‡ Procurement audit : formal review of procurement process. invoices and payment records. approvals vendor performance reports. ‡ Contract files : total set of indexed documents developed to include it in the final project records.Contract administration ‡ The process involves the following four steps: ‡ Contract documentation ± copy of contract. 01/01/2010 536 .

01/01/2010 537 . the project manager may have to compensate the vendor up to a certain amount as per the terms of the contract. ‡ If at the time of closing the contract.Contract administration ‡ Formal acceptance and closing: process wherein the contract administrator submits a formal written notice to the vendor saying that the contract is complete. the vendor has already incurred some expenditure on the project. ‡ The contract administration may have the authority (as per the contract terms) to decide to close a contract at any time.

± Change in the allocation of funds. ± Technological advancement that can bypass the product requirement. 01/01/2010 538 .Contract administration ‡ The possible reasons for the project administration to close the contract are: ± The product that was being procured is not required any more. ± Failure to supply the product or service as per the schedule. ± Availability of substitute products. ± Lack of profit expectancy.

the project administration may not pay the vendor or even recover the advance amount if given earlier.Contract administration --Lack of progress in the activities of the contract. ‡ If there is a breach of contract on the part of the vendor. --Failure to stick to the terms and conditions of the contract ± deviation from the contract in terms of quality and performance standards. 01/01/2010 539 .

partially accept or reject the products/services supplied by the vendor.Contract administration ‡ If the contract is terminated. the contract administrator has to check the breach of contract and then decide to accept. 01/01/2010 540 . ‡ He may then wait for some time to see if the end products/services supplied by the project are returned for rectification and if so determine the monetary value of the penalty to be charged to the vendor before finally settling his account.

‡ If the inventory is not properly handled.Contract administration ‡ Thus. occupying lot of space and precious working capital. terminating a contract is one of the challenging tasks of the contract administrator. 01/01/2010 541 . ‡ This will result in time and cost overruns. it may result in shortage when needed and may be available in plenty at other time. ‡ Project Inventory: The project materials occupy a sizeable chunk of the total materials required for a project.

the Just in Time strategy may be used by the project to save in inventory holding costs. ‡ Project Spares: Usually the OEMs provide the list of recommended spare parts as well as mandatory spare parts.Project Stores Management ‡ Therefore the requirement of inventory should be continuously monitored and managed. ‡ ³JIT´. which mostly the project managers procure. 01/01/2010 542 .

it is a common sight to see the project machinery being stored in open grounds gathering dust and rust till they are properly erected. ‡ In India. economic operation of the stores to give good timely service to the project. smooth running. even though a major chunk of the project investment is in the material. ‡ The responsibility of the stores manager is an efficient. the warehousing of the project material appears to be the most neglected. 01/01/2010 543 .Project Stores Management ‡ Among all the areas of Project management.

‡ Iron and steel items would corrode. ‡ materials containing wood get damaged by white ants. ‡ electronic instruments would be spoiled due to humidity. 01/01/2010 544 . ‡ fluids like petrol evaporate. heat and dust.Project Stores Management ‡ Obviously the stores manager requires adequate space to store the materials and a group of competent staff to handle them. ‡ The ill-effects of bad stores management: Materials like cement or paint would harden.

Project Stores Management ‡ storage batteries getting damaged due to humidity. 01/01/2010 545 . ‡ materials containing cloth and paper being eaten away by rats and cockroaches ‡ and the list can go longer. ‡ fire bricks disintegrate due to water. ‡ Glass sheets stacked one over another exposed to the sun crack.

sun¶s rays. fire. dirt. moisture. heat.Project Stores Management ‡ Thus the stores manager has to guard the project materials from light. 01/01/2010 546 . theft and pilferages. water. explosions. white ants. moths. dust. rats. oils. air.

h other fixed assets.Financing of the project ‡ A project may entail investment in : h land. the project manager has also to do the same exercise. h royalty. h distribution network and h working capital. h technical know-how. ‡ So. just like any corporate needs finance for its various activities and plans the appropriate structure of finance from various sources. 01/01/2010 547 . h advertisements. h plant and machinery.

01/01/2010 548 .Financing of the project ‡ So the questions that arise are: D What is the total cost of the project? D What should be capital structure? Which financing instruments? D Whether the sources should be internal or external? D If external. whether it should be private or public sources? D What should be the ideal cost of capital? D How much should be from short term and how much from long term? etc.

01/01/2010 549 . ± Term Loans. ‡ Pre-operative expenses. ± Preference Capital. ‡ The Means of Finance are as follows: ± Share Capital/reserves.Financing of the project ‡ Preliminary and capital issue expenses. ‡ Margin money for working capital and ‡ Initial cash losses. ± Private Equities/Venture Capital.

‡ Expenses on foreign technicians and training of Indian technicians abroad. ‡ Buildings and Civil works. 01/01/2010 550 . ‡ Technical know-how and engineering fees. ‡ Plant and machinery. ‡ Miscellaneous fixed assets.Financing of the project ‡ Cost of the project comprises of the outlay on account of: ‡ Land and site development.

leasing and hire purchase finance). ± Incentives and ± Other Miscellaneous sources (Unsecured loans. ± Deferred credits (from suppliers of plant and machinery).Sources of Finance ± Debentures. 01/01/2010 551 . public deposits.

Sources of Finance ‡ Planning the means of finance: The norms prescribed by the regulatory bodies and the financial institutions and the key business considerations of the project sponsor have to be kept in mind while planning the structure of the means of finance. 01/01/2010 552 . ‡ The norms of the regulatory bodies have the interest of the investors as one of the objectives. ‡ The norms of the financial institutions have the safe return of their funds with interest as their objective.

e.Sources of Finance ‡ The project sponsor will have the following factors in mind: ± cost of funds ±cost of debt is cheaper due to tax rebates on interest paid. 01/01/2010 553 . ± Control: the sponsors would like to have a programme of financing which enables to retain their control over the firm. amount of debt. whereas dividend tax has to be paid on the dividends paid out. ± Risk: Business risk arises from the variability of earnings and the financial risk arises from financial leverage i.

‡ While discussing the capital structure it is worthwhile to study the pluses and minuses of equity and debt by comparing them: 01/01/2010 554 .Sources of Finance ± Flexibility: the structure of finance should be such that the firm is able to borrow or raise further capital in future if necessary.

Creditors have a fixed claim in the form of interest and principal payment. to protect their interest 01/01/2010 555 . Dividends paid is not tax Interest paid by the firm is deductible tax deductible Equity has an indefinite life Debt has a fixed maturity Equity investors have the Debt investors play right to control the affairs passive role ± apart from of the firm imposing restrictions on the way the firm is run.Equity Debt Equity shareholders have a residual claim on the income and wealth of the firm.

debt finance is used (since the lenders¶ comfort level is more with the tangible assets) whereas for intangibles. ‡ Business Risk: . ‡ In general. for tangible assets. Equity is costlier but less risky.Sources of Finance ‡ Thus. 01/01/2010 556 . equity finance is preferred.the variability of earning power (=PBIT/total assets). whereas the debt is cheaper but more risky.

and proportion of fixed operating costs. ‡ The higher these variabilities and higher the fixed cost. ‡ As a general rule. 01/01/2010 557 . variability of input prices. ‡ A firm which facing more business risk should try to reduce its financial risk and vice versa.Sources of Finance ‡ The factors that bring to bear business risk are: Demand variability. the higher is the business risk that the firm would face. price variability. the combined business risk and the financial risk should be manageable.

‡ Market conditions: If the equity market is active and buoyant. 01/01/2010 558 . the firm may go in for more debt.33:1 for capital intensive infrastructure projects like power projects. then the firm may get a good premium for it¶s equity issues whereas if the market is depressed. ‡ Control considerations: Promoters who want to retain control over the affairs of the firm should have high proportion of equity.Sources of Finance ‡ Debt Equity norm of lenders: Lenders normally permit the Debt/Equity norms up to 1:1 but permit higher ratios up to 2.

‡ Public and private sources of capital: Debt as well as equity can both be raised from public (securities offered to public through µoffer documents¶ filed with the SEBI and made available through secondary markets)«««« 01/01/2010 559 .Sources of Finance ‡ Growth opportunities: When the firm has good growth opportunities. the firm should go for more equity whereas a firm which does not have much growth opportunity should go for debt.

Sources of Finance ‡ ««as well as private sources (loans given by banks. FIs. and HNIs. ‡ Retained earning is the (PAT minus the preference and equity dividend minus dividend tax paid. which is ploughed back in the firm.) ‡ Internal accruals: The internal accruals consist of the non-cash charges like depreciation and the retaining earnings.).. financial institutions. debentures privately placed with PE funds. 01/01/2010 560 . VC firms. or issue of equity/preference shares. MFs. Insurance cos.

Funds and the retained earnings and accordingly they may invest in projects of low return leading to 561 destruction of shareholders¶ wealth.Advantages of Disadvantages of Internal Accruals Internal Accruals Readily available to The available amount may be limited the management for use Eliminates issue The opportunity cost of the retained costs and losses on earnings is very high account of underpricing No dilution of control Opportunity cost of depreciation generated funds is the WACC. 01/01/2010 . Firms may underestimate the opportunity cost of dep.

5.100 or 1000 or it may be any integer.1. ‡ In India.50.2. Rs.20. 01/01/2010 562 .Sources of Finance ‡ Equity Capital: This is the capital collectively owned by all the equity shareholders. ‡ They rank as the last claimants to the assets of the firm and their liability is limited to the extent of their shareholdings. equity shares have a µpar value¶ ± may be Re.4.10.

e.) or any FPO (Follow on Public Issue ± which are subsequent Public Issues ). 01/01/2010 563 . at premium as per the advice of the Investment bankers to the issue.Sources of Finance ‡ Even in the case of IPO (Initial Public Offering ±the first Public Issue of the Co. ‡ In India. the shares may be priced above the par value i. shares cannot be issued at discount to the par values.

01/01/2010 564 . ‡ However in reality. if a company has to be liquidated. the equity shareholders may not get anything.Sources of Finance ‡ The equity shareholders have a right to income from their investments. right to appoint the Board of Director. have a right for additional shares proportionate to their existing holdings and the residual claims on the assets of the firm on liquidation.

resulting in the promoters holding the reins of control. it has been observed that the shareholders are indifferent and do not exercise their power effectively. may not be substantial.Sources of Finance ‡ In India. 01/01/2010 565 . even if their holdings in the co.

So the co.The advantages and disadvantages of the equity capital are: Advantages Disadvantages No legal consequences of skipping dividends. need not pay dividends if there are no sufficient earnings or when the profit is required to be ploughed back due to good investment opportunities 01/01/2010 Sale of equity dilutes the control of the existing shareholders 566 .

No maturity date and Rate of return required by hence the co. need not the equity investors is redeem them generally very much higher than the requirement of the other investors The larger the equity. whereas interest capacity of the firm to payments are tax raise debt finance deductible Equity dividends are exempt from income tax at the hands of the 01/01/2010 equity shareholders Cost of issuing equity is high due to underwriting commission. Dividends are paid out of the larger is the PAT. brokerage 567 costs .

‡ Preference dividends are payable only out of distributable profits but paid before the equity shareholders are paid. ‡ The Preference dividend is not a tax deductible payment for the company.Sources of Finance ‡ Preference capital: . 01/01/2010 568 . ‡ Usually the preference dividend amount is fixed and much lower than the rate of dividend paid to the equity holders.a hybrid instrument having some characteristics of equity and some of the debentures.

(In India. ‡ There are different types of preference shares: Cumulative and non-cumulative preference shares. and convertible and non-convertible preference shares.Sources of Finance ‡ Preference equity holders do not have the right to vote and their residual claim ranks above the equity shareholders. redeemable and nonredeemable preference shares. 01/01/2010 569 . participating and non-participating preference shares. issue of Non-redeemable preference shares is not permitted).

case of non. preference shares 01/01/2010 570 . it is costlier than debt No redemption Preference share holders¶ liability in the claim to the assets of the co.Advantages and disadvantages of preference capital: Advantages Disadvantages No legal Since dividends paid to obligation to pay preference share holders is dividends. not tax exempt.are prior to the claims of the redeemable equity share holders.

. skips worth if redemption is preference dividends for subordinated to debts three years. Considered part of net If the co.Advantages and disadvantages of preference capital««. voting rights have to be given to the preference share holders No voting rights and hence no dilution of control 01/01/2010 571 .

promises the debenture holder to pay interest periodically at the indicated rate and redeem the debenture on the maturity date. The Co.Sources of Finance ‡ Debentures: Debenture is an alternative to term loan. ‡ The features of debentures are: ± A Trustee. 01/01/2010 572 . fulfils its contractual obligations. usually a bank or a financial institution or an insurance company is appointed to take care of the interests of the debenture holders to see that the co.

Sources of Finance ± Secured debentures are secured by mortgages or charge on the immovable properties and a floating charge on the other assets. Debentures may also be unsecured. 01/01/2010 573 . ± These are medium term (1 to 5 years) or long term (more than 5 years) instruments ± Debentures for periods 18 months or above have to be compulsorily rated ± For debentures of over 18 months DRR has to be created and built up to at least 50% before the redemption date.

± Debentures may be issued with the feature of partial or full conversion facility at the end of a certain predetermined period. ± The interest paid on the debentures is a tax deductible expense for the co. 01/01/2010 574 .Sources of Finance ± They may carry fixed or floating rate of interest (linked to a benchmark such as the treasury bill) (or zero interest in the case of deep discount bonds) ± They may have in-built features of µcall¶ and µput¶ options in favour of the issuers.

Sources of Finance ± (Part or full amount of the Debentures are converted into shares at the predetermined premium) ± Convertible debentures are generally popular since the interest payable on them is lower than non-convertible debentures and also lower than the bank interest the co. and enables the co. to convert the debenture amount into shares at premium. would have paid for a bank loan. 01/01/2010 575 .

(FV Rs. 75 towards principal + Rs.Sources of Finance Secured Premium Notes (SPNs): This is a new instrument introduced by TISCO in 1992. Repayments at the end of 4th year to 7th year : Rs.) 01/01/2010 576 . 75 towards interest and a warrant of entitlement of one share at Rs. in four instalments at the end of the 4th to 7th years. 80 at the end of the 7th year. 300. ‡ This is akin to a debenture with the interest payments staggered and paid along with part of the principal.

each for Rs.at the end of 12 years.Sources of Finance ‡ Indexed bonds: ICICI issued such bonds in 1997. 6000: ‡ It contained two parts ± one was a deep discount bond with redemption value of Rs. 01/01/2010 577 . ‡ The second part was a small amount of Rs. 22000/. 2000 the amount of repayment being calculated as 2000*BSE sensex2000/BSE Sensex1997.

The advantages and disadvantages of debt financing are: Advantages Disadvantages Interest paid on debt is tax deductible expense whereas dividends paid on equity or preference shares are paid out of PAT Failure to make the timely interest and principal repayments may cause bankruptcy of the firm Does not result in Increases financial dilution of control leverage and hence according to CAPM increases the cost of 01/01/2010 578 equity .

then the cost of debt would prove to be higher than expected 579 . If the rates of inflation falls. the shareholders may default on debt and transfer the firm to the 01/01/2010 creditors Debt covenants impose restrictions limiting the firm¶s financial and operating flexibility.The advantages and disadvantages of debt financing are««: Creditors entitled only to the interest and principal and not to the value created out of the debt If there is a significant decline in the value of the firm.

it protects the firm against high inflation Maturity of a debt instrument can be adjusted to the needs of the firm 01/01/2010 580 .The advantages and disadvantages of debt financing are««: Issue cost of debt is very much cheaper than that of equity/preference issues Since interest is fixed in nominal terms.

approaches the share holders for approval.Sources of Finance ‡ Methods of offering: IPO/FPO/Bonds/Rights Issues/Private Placements/Preferential allotments. the identity of the investors is not known when the offer document is prepared. VC funds. MFs. ‡ Private placement and preferential allotments involve sale of securities to a limited number of sophisticated investors like FIs. whereas in the case of Private placements. the identity of the investors is known when the co. 01/01/2010 581 . ‡ In a preferential allotment.. banks and so on.

Sources of Finance ‡ In India Private placement refers to allotment of securities of a listed or unlisted co. Placements do not require registration with SEBI. In place of road shows. Preferential allotment refers to allotment of securities of a listed co. ‡ Pvt. the company hosts potential investors¶ meet and gives presentation. 01/01/2010 582 . ‡ A µPrivate Placement Memorandum¶ is prepared in place of the prospectus.

‡ The rationale for preferential allotment is to secure the equity participation of those the company considers desirable. strategic investors. 01/01/2010 583 . VCs. FIs and suppliers. but who may otherwise find it very costly or impractical to buy large chunks of shares in the market.Sources of Finance ‡ Generally preferential allotment is made to promoters.

that can be Large raised Cost of issue Dilution of control Degree pricing of High Yes Preferential Pvt.Comparison of the various methods of offering with each other: Public Issue Amt. Placem allotment ent Modera Modera Moderate te te Rights Issue Negligi Negligi Negligible ble ble No Yes Depends Irreleva Small nt No under Large Market perception 01/01/2010 Negati Neutral Neutral Neutral ve 584 .

for the purpose of setting up new projects. 01/01/2010 585 . or expansion. ‡ Banks and FIs give rupee terms loans as well as foreign currency term loans.Sources of Finance ‡ Term Loans: These are used to finance acquisition of fixed assets and working capital margin. modernisation or renovation of existing of units.

machinery and equipment. payment of foreign technical know-how fees etc.Sources of Finance ‡ FC loans are used for the import of plant. ‡ The assets that are created out of the loan form the main security for the loans and any other securities may form the collateral securities. 01/01/2010 586 . ‡ Repayment liability of principal and interest remains in FC and converted into rupees at the time of payment at the then ruling rates.

the term lending FIs which finance the acquisition of fixed assets and the banks which finance the working capital requirements are in constant touch with each other and coordinate the lending activities.Sources of Finance ‡ Usually. 01/01/2010 587 . while monitoring the accounts of the borrower. ‡ The FIs have the µfirst charge¶ over the assets which they have financed and have the µsecond charge¶ over the assets financed by the banks.

IIFCL. EXIM Bank. IDFC. ‡ Thus all the assets of the firm are charged to the lenders. IDBI and ICICI were in this category but have been converted into banks. GIC. 01/01/2010 588 . SIDBI.Sources of Finance ‡ The banks have the first charge on the assets they finance and have the second charge on the assets financed by the FIs. ‡ There are three types of term lending institutions: ‡ All India FIs: IFCI. LIC. PFC. IDBI. IL FS.

: These banks do not extend term loans for periods beyond 5-8 years normally. till the project starts commercial production . the lenders also charge a ³processing fee¶ of about 1% of the loan amount. ‡ Commercial Banks. ‡ There may be an initial repayment holiday. 01/01/2010 589 . since their focus is on short and medium terms.Sources of Finance ‡ State Level FCs: SIDCs and SFCs. ‡ For term loans.

01/01/2010 590 . quarterly or half yearly intervals depending on the cash flows projected.e. the project manager has to correctly calculate the cash outflows on account of these dues.Sources of Finance ‡ Thereafter the repayments of the principal and interest due would begin at monthly. ‡ Since the lending institutions will charge penal interest on the µoverdue¶ amounts (i. the amounts of principal and or interest not paid on due dates).

Sources of Finance Usually the loan documents stipulate certain covenants such as: the board should have a nominee from the lenders. restrictions on transfer of shares of promoters to others. 01/01/2010 591 . bar to undertake any new project until the dues are paid in full. additional funds should be brought in by the promoters in case of overrun. payment of dividends with the permission of lenders etc.

01/01/2010 592 . Projected financial statements etc. in the lending institution¶s standard form along with the necessary enclosures like the Project Report. Initial processing by FI to check whether the application is complete. appraisal of the project.Sources of Finance Procedure of sanction of term loan by the FIs/banks: Application by the co.

Initial processing by FI to check whether the application is complete. 01/01/2010 593 . appraisal of the project. along with the detailed list of terms and conditions/covenants.Sources of Finance Procedure of sanction of term loan by the FIs/banks: Application by the co. Projected financial statements etc. Sanction of the proposal by the appropriate authority and issue of the Sanction letter to the co. in the lending institution¶s standard form along with the necessary enclosures like the Project Report.

‡ Depending on the size of the loan. disbursement of the loans in stages as agreed between the lenders and the co. and monitoring of the progress of the project and recovery of the interest and principal. the co. more than one bank/institution may participate in the lending with a view to share the risk.Sources of Finance creation of charges in favour of the lenders. In such a case. 01/01/2010 594 . appoints one bank as the µlead bank¶ . and prepares an µInformation Memorandum¶. depending upon the projected cash flows.

can draw for its operations. finance is given in the form of Cash Credit/Overdraft/Letter of Credit. called the µlimit¶. 01/01/2010 595 . ‡ In the pre-production stage. the bank fixes the maximum amount that the co. This process is known as µSyndication¶ ‡ Working Capital Advances: Used for financing the current assets.Sources of Finance The lead bank enlists the services of some other banks in sharing the lending based on the Information Memorandum. ‡ Under the Cash Credit/Overdraft system.

‡ The operations are reviewed at the end of every year and then renewed for another year. the limit amount assessed for working capital needs of the co. is given in the form of a loan and interest is charged on the entire loan amount till it is repaid.Sources of Finance ‡ Interest is charged periodically on the actual amount utilised by the co. 01/01/2010 596 . ‡ In the case of loans.

and on receipt of the stipulated documents form the supplier. 01/01/2010 597 . the supplier of RM may demand an LC in which case the bank gives the LC facility also to the co. as part of the WC limits. ‡ LC is opened in favour of the supplier of the RM. ‡ The amount is then recovered by the bank from the co. the bank pays the supplier.Sources of Finance ‡ In some cases.

Thus the cycle goes on. some of whom avail some credit periods for repayment.Sources of Finance ‡ In the post production stage.¶s debtors and credits the amount to the Cash Credit/Overdraft account. sells its products. ‡ The bank discounts such bills on the co. ‡ There are other miscellaneous sources of finance and they are: 01/01/2010 598 . the co. raises bills on its customers.

‡ However the supplier extending such deferred credit is subject to a bank guarantee. which would be part of the credit facilities extended by the bank to the co.Sources of Finance ‡ Deferred credit: Suppliers of capital goods usually offer long term credits.. 01/01/2010 599 . to avail the deferred credit. ‡ If the rate of interest loaded in the price is less than the bank¶s rate. it would be advantageous for the co.

‡ Leasing of industrial equipments is a form of debt finance. A Lease finance represents a contractual arrangement whereby the lessor grants the lessee the right to use an asset in return for periodic lease rental payments.Sources of Finance ‡ Lease and Hire Purchase finance. Two types of leases: Financial and Operating leases: 01/01/2010 600 .

The differences between Leasing and Hire Purchase is tabulated below: Leasing Hire Purchasing Lessee cannot claim depreciation The entire lease rental is a tax-deductible expense for the lessee The lessee not being the owner does not get the benefit of the salvage value of the asset 01/01/2010 Hirer is entitled to claim depreciation Only the interest component of the hire purchase instalment is a tax-deductible expense The hirer being the owner of the asset. gets the benefit of the salvage value of the asset 601 .

Sources of Finance ‡ Unsecured loans and deposits: These are the loans provided by the promoters themselves or their friends and relatives to make up the shortfall of the required promoters¶ stipulated contribution. cannot be repaid without the permission of the FIs and till their loans are cleared. 01/01/2010 602 . ‡ These loans usually carry a rate of interest lower than those on loans from the FIs.

since the covenants that apply to loans from FIs do not apply.Sources of Finance ‡ Some well known companies prefer to collect deposits from the public for periods depending on their cash in flow. 01/01/2010 603 . ‡ However new companies may not be able to raise such deposits since their track record is yet to be built to attract the attention and confidence of the public.

discount them with their bankers who in turn rediscount them with IDBI to refinance themselves. where the bank discounts the long term Bills of exchanges of the sellers after they are accepted by the buyers and co-accepted (µavalised¶) by their bankers. 01/01/2010 604 .Sources of Finance ‡ Special schemes of institutions: Sellers of Capital equipments offer long term credits to their buyers by obtaining their accepted Bills of exchanges. ‡ ICICI operates a ³Suppliers¶ Credit´ Scheme.

01/01/2010 605 . ‡ In addition some states offer sales tax exemptions (on materials purchased from the state) and deferments for a few years. ‡ The deferments are equivalent to interest free loans.Sources of Finance ‡ Subsidies and sales tax deferments and exemptions: Some states offer subsidies to projects located in their states by giving them a sizeable amount of the project cost say even upto 25% subject to a certain maximum amount.

Sources of Finance ‡ Short term loans from financial institutions : Companies with good financial track records are offered short term ± one year²loans without any securities for tiding over their financial difficulties. (See RBI¶s website for the latest guidelines :http://www.in/scripts/BS_ViewMasterCircular 01/01/2010 606 s. the discount representing the interest on the CPs.rbi. These are called µCorporate loans¶. ‡ Commercial papers: Companies with good credit rating may issue CPs which are unsecured promissory notes for periods not more than six months.org.aspx?Id=4285&Mode=0) . ‡ These are sold at discounts to the face values and redeemed at their face values.

01/01/2010 607 . PNB Factors and Allahabad Factors have been authorised by RBI to serve the western. rated and then securities are issued to the investors giving them the bundle of securities as collateral securities.Sources of Finance ‡ Factoring: µFactors¶ are FIs which extend finance upto 80% of the receivables of their customers and also manage the receivables. ‡ Securitisation: It is a method adopted to liquefy the assets of a firm which has got receivables. northern and eastern parts of India. ‡ SBI Factors. Can Factors. ‡ The assets are bundled. southern.

01/01/2010 608 . the SPV is entitled for an appropriate fee.Sources of Finance ‡ The pool of securities are normally transferred to an SPV which holds the securities in trust for the investors for which service. ‡ The securities are called Pass Through Certificates (PTCs). ‡ The pool may be divided into different classes depending on their rating and the PTCs may be issued against each distinct rated class of securities.

‡ Raising Venture Capital: If a co.Sources of Finance ‡ Obviously the PTCs issued against the best rated securities will carry the least rate of interest and will be redeemed first. 01/01/2010 609 . which is not yet known to the public cannot approach them with the offer of a Public Issue to raise finance for its needs.

by divesting through µOffers¶ to retail investors at premium or to other entrepreneurs with a good margin of profit. 01/01/2010 610 . the VCs exit the co. experienced. committed and determined and then invest in the co. talented.Sources of Finance ‡ The Venture Capitalists (VCs) study the entrepreneur¶s and his business¶s potential to satisfy themselves that the entrepreneur¶s management team is capable. ‡ After a few years.

org.Look up for the same in their website: http://www. an Indian entrepreneur can now approach off-shore markets. maximum rate of interest outflow etc.rbi. limits of borrowing. 01/01/2010 611 . RUFs) in any currency. or markets in other countries for raising capital (ADRs.Sources of Finance ‡ Raising Capital in the international markets: Due to the globalisation of the Capital markets.aspx .. ‡ The RBI has issued detailed guidelines about the External Commercial Borrowings (ECBs) --about the eligibility of the borrowers. GDRs) or borrowing (syndicated loans) or issue bonds (FRNs. .in/scripts/BS_ViewMasterCircul ars.

especially the Eurocurrency loans offers the following advantages: ± Participating institutions have a very professional approach and have huge funds at their disposal to give loans of any amounts. ± Tenors of the loans may go even up to 10 years. ± A lot of flexibility is availability in structuring the loans. 01/01/2010 612 .Sources of Finance ‡ Evaluation of overseas debts: Overseas debt.

± Interest rates charged depends on the risk perception of the lender/lead lender. ± May be difficult to negotiate with the investors.Sources of Finance ‡ The disadvantages are : --ECBs are not economical for small projects due to costs involved for appraisal and syndication. 01/01/2010 613 .

‡ The shares issued by the co. are held by a depository. These GDRs are listed and traded in major stock exchanges in Europe. 01/01/2010 614 .Sources of Finance ‡ Global Deposit Receipts (GDRs) : These are indirect equity investments issued in $s in the Euromarkets. ‡ Each DR represents a certain number of shares. usually a large international bank which receives all the benefits of the underlying shares and distributes to the holders of the DRs.

‡ American Depository Receipts (ADRs): ADRs are similar to the GDRs except for the fact that they are listed in the Stock Exchanges in the USA and attract more stringent disclosure conditions imposed by the SEC. ‡ Since GDRs are FDIs.Sources of Finance ‡ The issuer pays dividends in the home currency to the Depository which is converted into $s and paid by the Depository to the holders. appropriate permission has to be obtained from the FIPB and RBI. ‡ The holders of the GDRs can convert the DRs into shares at any time by surrendering them to the Depository. 01/01/2010 615 .

There may be in fact additional obligations to be fulfilled by the foreign issuers.) ‡ The foreign issuer has to satisfy all regulations applicable to the domestic firms. 01/01/2010 616 . have already tapped the US.Sources of Finance ‡ Foreign Domestic markets: Another way to raise money internationally is to sell securities directly in the domestic capital markets of foreign countries.UK. issuing securities in $s in the capital markets of USA. Japan and Switzerland markets. ‡ Example would be an Indian co. ‡ (Indian cos.

Sources of Finance ‡ The US Capital Market is the largest with a very active derivatives market also.) 01/01/2010 617 .. Japanese Yen and Australian $s in the respective countries by issuers of other countries. Yankee bonds can be issued to QIBs without much restrictions which are applicable to the securities issued to the general public. 144A under the Securities Act of 1933. ‡ Similarly Bull Dogs. Pds. ‡ Under Rule No. ‡ (Yankee bonds are bonds issued in $s in USA by issuers of other countries. Samurais and Matilda or Kangaroos are bonds issued in Stg.

‡ Both Buyers¶ credits as well as Suppliers¶ credits are provided. ‡ Under the µBerne Union¶ conventions. the EXIM banks¶ interest rates applicable for export credits to Indian companies are regulated.Sources of Finance ‡ Export Credit Schemes: The Governments of a number of countries like US. Japan and India have created µEXIM¶ banks for financing exports of capital goods and related technical services. 01/01/2010 618 .

‡ The steps involved in this process are: ‡ The overseas exporter and the Indian buyer negotiate the contract. 01/01/2010 619 . processed by the agency and is approved.Sources of Finance ‡ Buyers¶ Credits: Under this Scheme. ‡ Application for the Buyer¶s credit is submitted to the Export Credit Agency of the exporter¶s country. credit is provided directly to the Indian buyer of capital goods/technical services from the overseas exporter.

Sources of Finance ‡ The loan agreement containing the terms and conditions of the buyer¶s credit is negotiated between the exporter¶s bank and the Indian borrower (and the guarantor if any of the Indian borrower) and entered into. 01/01/2010 620 . ‡ Suppliers¶ Credit: This is a credit provided to the overseas exporters so that they can make available medium term finance to Indian importers.

‡ The export credit agency communicates its willingness to provide the facility. 01/01/2010 621 . requiring medium term finance.Sources of Finance ‡ The steps involved in the process are: ‡ The overseas exporter notifies his bank and the export credit agency of a potential export order from an Indian buyer. ‡ The terms of the facility are incorporated in the contract between the overseas exporter and the Indian buyer.

‡ Up to 85% of the value of imports is available as finance. ‡ Finance is provided against the guarantees of the buyer¶s bank (in the case of buyer¶s credit) and the seller¶s bank (in the case of seller¶s credit). 01/01/2010 622 .Sources of Finance ‡ The salient features of the finance provided by the export credit agencies are: ‡ The finance is tied to import of goods and services. ‡ Finance available for long tenors at reasonable cost.

Sources of Finance ‡ Project financing structures: Full recourse structure and Limited recourse structure: ‡ Full recourse structure: The features are: ‡ If the project is implemented by a new company. then the new lender gets a µpari-passu¶ charge over all the existing and future assets of the co. are backed by charge on all the existing and future assets of the co. ‡ If an existing co. along with the other lenders. the borrowings of the co. 01/01/2010 623 . borrows for a new project.

01/01/2010 624 .Sources of Finance ‡ The viability of the project would be assessed on a stand-alone basis but the stand alone cash flows as well as the total cash flows of the company are taken into account to judge whether the company would be in a position to service the existing as well as the proposed debts. the lenders sometimes insist on the personal guarantee of the promoters also and a corporate guarantee of one of the group companies. ‡ In addition to the above charges.

The salient features of the structure are: ‡ The project is set up as a separate company as an SPV. 01/01/2010 625 . ‡ The pvt.Sources of Finance ‡ Limited recourse structure: Of late private participation in infrastructure projects is increasing. sector promoter usually takes a major stake in the equity of the project and enjoys the over-all responsibility for running the project.

01/01/2010 626 . ‡ The cash flow of the SPV is handled by a Trust or in an escrow account for appropriating the cash flows in the predetermined manner for various requirements of the project as well as debt servicing. After all the requirements are met.Sources of Finance ‡ The pvt. the residual cash flow is available to the project company. sector promoter provides stand-by support for cost overruns if the quantum of such support is crystallised before the financial closure.

financial closure takes more time since the lenders have to satisfy themselves about all the issues concerned before committing their funds. 01/01/2010 627 . ‡ Generally in the case of infrastructure projects. the government guarantee may be available. ‡ Financial closure: Financial closure means that all the sources of funds for the project have been tied up.Sources of Finance ‡ In some cases. ‡ Lenders do not have recourse to the sponsors and their other assets.

financial closure can be achieved early if: ‡ Suitable credit enhancements (additional securities) are done to the satisfaction of the lenders. ‡ The credit worthiness and reputation of the sponsors is well established and ‡ The proposal is simultaneously processed by all the proposed lenders and coordinated among themselves.Sources of Finance ‡ In general. 01/01/2010 628 . ‡ Underwriting arrangements are made for market related securities offerings.

Cost of Capital ‡ The cost of capital assumes significance since: ‡ The project has to earn an IRR which can satisfactorily meet the cost of the funds obtained for financing the project. ‡ It is used as the discount rate to determine the NPV of the project or the cut-off or the hurdle rate with which to compare the IRR. 01/01/2010 629 . ‡ Understanding of the cost of capital is essential to take the correct decision about the LT as well as ST borrowings. leasing etc.

the weighted arithmetic average of the cost of the different sources constitutes the firm¶s cost of capital. the project financing mix has to be adjusted in such a manner as to result in as low a cost of capital as possible. 01/01/2010 630 . ‡ Composite Cost of Capital: When the firm gets its LT funds from different sources.Cost of Capital ‡ Where different sources of funds are employed.

15%) = 16. Then the composite cost of capital would be: (0.7 * 0.Cost of Capital ‡ Let us take a simple example: A firm has 30% equity with cost of equity at 20% and LT debt of 70% with cost of debt at 15%. second«nth source and k1. k2«. second«nth sources of finance. where p1. 01/01/2010 631 . ‡ By extending the number sources of finance to n.3*0.2%) + (0.5%. the composite cost of capital = p1k1+p2k2+««+pnkn. p2«pn are the proportions of the first.kn are the costs of the first.

cost of preference equity and cost of debt respectively and w1. retained earnings. cost of equity. ke. where K0. to the total capital employed. 01/01/2010 632 . the formula can be restated as follows: ‡ K0 = w1ke+w2kr+w3kp+w4kd.. w4 are the respective weights representing the proportion of capital from the concerned source . preference shares and debt is considered. w3. w2.Cost of Capital ‡ If a combination of equity. kp and kd are the Composite cost of capital. cost of retained earnings. kr.

‡ Since project financing concerns the present and the future transactions of raising equity or contracting debts.Cost of Capital ‡ See some examples in the notes. 01/01/2010 633 . ‡ Cost of equity capital: It is the minimum rate of return that is expected on the equity financed portion of its investments in order to keep in tact the market price of the firm¶s stock. we should consider the marginal cost of the specific sources of financing we are selecting and not the weighted average of the existing mix of finance.

as a framework for investment projects. ‡ The CAPM. ‡ In the Historical Rate of return approach. the past rate of earnings on equity is taken as the basis for determining the future cost of equity capital. CAPM and Dividend growth model.Cost of Capital ‡ Some of the methods of computation of the cost of equity are : Historical rates of return. implies that projects should be judged with reference to their systematic risk. 01/01/2010 634 .

01/01/2010 635 . ‡ Dividend Growth Model: In this model.Cost of Capital ‡ The appropriate discount rate for the project is given by the formula: Ki = Rf + i (km ± Rf) :where Ki = rate of return required on equity. the cost of equity will be the market rate of discount that equates the present value of all anticipated future dividends with the prevailing price of the stock. km = i = beta of security and rate of return on the market portfolio. Rf = Risk free rate of return.

Cost of Capital ‡ If dividends are expected to grow at a constant rate g. where D1 = the dividend that is expected to be paid at the end of period 1 and P0 is the value of a share of stock at time 0. the cost of equity is given by the equation: Ke = (D1/P0) + g. ‡ For example. and the cost of equity ke >g. if a company expects to pay a dividend of Rs. 15 per share at the end of period 1. and that the co¶s earnings and dividend per share are expected to grow««« 01/01/2010 636 .

at 3% in line with the growth in the economy and the current price of the share is Rs. 01/01/2010 637 . the equation can be modified to incorporate such deviations. ‡ Whatever be the model. the measure of cost of equity would only be an approximation and not precise.03 = 11. 180. the cost of equity capital will be : ke = (15/180) + 0. and a tapering off of the growth rate is anticipated.Cost of Capital ‡ ««.33% ‡ (If constant growth rate in the dividend cannot be assumed .) . if they are defined in terms of the time frame and quantum.

then the marginal cost of capital would reflect the riskiness of the proposed investments.) 01/01/2010 638 .¶s policies are : ‡ Investment policy (If the riskiness of the proposed investment is different from the riskiness of the existing investments. some of which are dependent on the investment and financing policies of the co. ‡ The factors which depend on the co. and some are beyond the control of the co.Cost of Capital ‡ Factors affecting the weighted average cost of capital: The WACC is affected by several factors.

‡ The level of interest rate : Depending on the prevailing levels of interest. ‡ Tax rates. the cost of debt and preference capital may change. Even the cost of equity will depend on the levels of interest rate since it affects the risk free interest rate. may adopt the appropriate level of financial leverage.Cost of Capital ‡ Capital Structure Policy: Since the post tax cost of debt is cheaper than the cost of equity. the co. ‡ Dividend Policy. ‡ Market risk premium : This is the perceived risk of equity stocks. 01/01/2010 639 .

where ki = the net proceeds of the debt issue. adjusted for the tax effect. k is the IRR or yield and t represents the tax rate.Cost of Capital ‡ Cost of Debt : The after tax cost of debt is the discount rate which equates the net proceeds of the debt issue with the present values of the outflows in the form of interest and principal repayments. The equation is : ki = k(1-t). ‡ If interest is paid annually and redemption at maturity. the equation will become:«« 01/01/2010 640 .

F= redemption price. t = tax rate. C= Interest per annum. t = 1 (1 + kd)1 (1 + kd)n where P = net proceeds of the debt issue. 01/01/2010 641 . n= maturity period of debt.Cost of Capital n ‡ P=7 C (1-t) + F .

dividend is paid instead of interest. the difference being pref. capital instead of kd the cost of debt. capital is similar to debt.Cost of Capital ‡ Cost of preference capital: The case of redeemable pref. i = 1 (1 + kp)i (1 + kp)n 01/01/2010 642 . where. ‡ So the equation is: n P=7 D + F .. tax is not applicable and the discounting rate is kp the cost of pref. .

kp = post tax cost of debt and n = maturity period of pref. ‡ The approximate cost of preference capital is given by the equation: kp = D + (F-P)/n (P + F )/2 01/01/2010 643 . share. F = redemption price. dividend per share payable annually. D= pref. share.Cost of Capital ‡ P = net proceeds per pref.

31% (10 + 9. if a company issues pref.9.Cost of Capital ‡ For example.50)/10 = 10. the cost of pref.75 01/01/2010 644 .50)/2 9. and the net amount realised per share is Rs. redeemable after 10 years. 10 with a dividend of 10%.50. share capital will be: 10 + (10-9. shares of face value Rs.05 = 10.

Cost of Capital ‡ Financing of project expansion: A new project may be implemented as a division of the parent co or it may be implemented through a separate company. then the internal resources of generated by the co. term loans. ‡ The other sources are unsecured deposits from the public. and issue of capital or debentures. can be partly used as it may not be sufficient.. 01/01/2010 645 . ‡ If implemented as a division of the co.

01/01/2010 646 . Corporate Loan. implementing early retirement scheme. supplementing working capital and repaying high cost debt . ‡ Short-term Loans (upto two years) for different short term requirements including bridge loan. Corporate Loan etc ‡ Medium-term Loans (more than two years to eight years) for business expansion. ‡ The All India FIs are: IFCI: IFCI offers the following wide range of products.IFCI  Financial institutions may be broadly categorised into two categories: All India financial Institutions and State Level FIs. R&D expenditure. technology upgradation.Financial Institutions.

IPO finance. Securitisation of debt ‡ Structured Products: acquisition finance. ‡ Lease Financing ‡ Takeover of accounts from Banks / Financial Institutions / NBFCs. 01/01/2010 647 .Project Finance for new industrial/ infrastructure projects. Corporate Loan. preIPO investment. µTakeout Finance¶. acquisition financing (as per extant RBI guidelines / Board approved policy).IFCI ‡ Long-term Loans (more than eight years to upto 15 years) . etc. promoter funding.

01/01/2010 648 . ‡ Major Financing Schemes of IFCI includes Project Financing and Financial Services mainly to the manufacturing industry along with a diversified industrial portfolio.IFCI ‡ Financing promoters¶ contribution (private equity participation)/subscription to convertible warrants ‡ Purchase of Standard Assets and NPAs ‡ IFCI customizes the product-mix to suit the business/industry. ‡ Targeted Business Segments: IFCI has been meeting the changing requirements of the clients through financial products for multiple industry sectors.

IFCI ‡ Public Sector Undertakings ‡ Manufacturing industry ‡ Infrastructure projects ± Power ± Airports (brown field) ± Ports ± Hotels ± Urban infrastructure projects ‡ NBFCs ‡ Participation in Private Equity ± Promoter funding 01/01/2010 649 .

650 01/01/2010 .IFCI ‡ ‡ ‡ ‡ ‡ ‡ ‡ Corporate Advisory Services Corporate advisory & infrastructure services Infrastructure advisory Monitoring agency for public issues Restructuring advisory services Bid process management Corporate advisory & infrastructure services: India is throwing up investment avenues in newer sectors and projects. and IFCI fills up the critical need to provide specialised advisory services to the Indian Corporate Sector in their efforts towards Industrial Advancement.

Financial Engineering. DPR.IFCI ‡ As a catalyst of Industrial growth. ‡ Credit Syndication including preparation of Information Memorandum. ‡ Project Conceptualization and related services. Preparation of feasibility studies. Post Sanction follow-up. 01/01/2010 651 . IFCI provides the following Advisory Services: ‡ Investment appraisal of Navratna (most valued public sector companies) Companies. Assistance in legal documentation etc. Capital Structuring. including Guidance in relation to Selection of Projects. Project Management Design etc. Syndication of domestic/foreign loans. Techno-economic Feasibility.

01/01/2010 652 . ports. with specific emphasis on roads. ‡ The services provided in the Infrastructure Sector include: ‡ Facilitation of Credit Documentation.IFCI ‡ Documentation of various project documents. ‡ Due Diligence. ‡ Infrastructure advisory: ‡ IFCI offers a range of services to the Infrastructure Sector. power and urban infrastructure total solutions starting from the stage of investment identification to financial closure are provided.

Assessment & Reasonableness of Cost. 01/01/2010 653 . ‡ Pre-Investment Review. ‡ Financial Analysis & Modeling ± Scenario Analysis.IFCI ‡ Agreements & Document Review/Advice. Cost & Risk. ‡ Risk Allocation. ‡ Potential JV/Partner Profiling. ‡ Project Conceptualization and Feasibility Studies. ‡ Advise on Financing Options ± Sources.

Placement of debt & equity.IFCI ‡ ‡ ‡ ‡ ‡ ‡ ‡ Negotiating Support for Equity Buy In. 654 01/01/2010 . Project Evaluation. As per the SEBI (Disclosure & Investor Protection) Guidelines. ECB. Capital Market Advisory Services. Credit Syndication ± Domestic & Overseas. the issuer shall make arrangements for the use of proceeds of the issue to be monitored by one of the financial institutions. in case of issues exceeding Rs. 2000. Arranging Deferred Payment Guarantee.500 crore.

till the completion of project. 01/01/2010 655 . ‡ Ascertaining whether the utilization of issue funds has been made for the purposes and in a manner as envisaged by the Offer Document. for the purposes of record. ‡ Preparation of Monitoring Report as per the format specified at Schedule-XIX of the above guidelines. ‡ Submission of the report to the SEBI on a halfyearly basis.IFCI ‡ IFCI offers its services as Monitoring Agency for the same: ‡ Carrying out of Post-Issue due diligence.

IFCI ‡ Restructuring advisory services: ‡ Advisory Services to corporate and government clients comprising financial restructuring. cost-structure studies and process analysis & improvement: ‡ Organizational Structural Changes ‡ Analysis of the Operational Performance. ‡ Market Analysis with respect to products. ‡ Study of the Existing Statutes & Rules and Regulations. operational restructuring. 01/01/2010 656 . ‡ Study of the Existing Organizational Structure.

divisions and corporate entities. brands.IFCI ‡ Review of the Domestic & International Scenario. assets or liabilities. ‡ Separation. 01/01/2010 657 . ‡ Preparation of relevant Agreements/ Legal Documents. ‡ Advising on Formation of New Entity. business operations. ‡ Valuation of Fixed Assets and Inventory. operating and technology rights. ‡ Buy/Sell Advisory ‡ Purchase. disposal of non-strategic ventures. liquidation. sale. transfer of assets.

‡ Locating suitable counter-parties. 01/01/2010 658 . ‡ Determining of share exchange ratio. Joint Ventures and Alliances ‡ Drafting information memoranda for potential buyers/ sellers. transaction and transition process. ‡ Assessing and advising on augmenting the viability.IFCI ‡ Mergers. ‡ Managing and monitoring of the documentation. ‡ Structuring and negotiating of terms and conditions for the new entity.

‡ Assessment & Valuation of assets. to prepare an appropriate package. ‡ Financial restructuring. ‡ Valuation of company as a going concern. ‡ Bid process management: ‡ IFCI has successfully handled several Bid Process Management Assignments. if any.IFCI ‡ Privatisation ‡ Conducting the SWOT Analysis and based on the same. 01/01/2010 659 . ‡ Preparation of Information Memorandum. ‡ Suggesting measures to enhance sale value.

IFCI ‡ IFCI offers a range of services under the Bid Process Management: ‡ Preparation of Bid Documents (for various modes of Bid process) and Advertisement inviting Expression of Interest (EOI). ‡ Evaluation of Bids and Assisting till the final award of Contract. It also has soft loan schemes and provides Risk Capital Assistance sponsored by the Risk Capital and Technology Finance Corporation Ltd. ‡ It provides long term finance to the industries and issues guarantees on their behalf. 01/01/2010 660 .

extending underwriting assistance and issuing guarantees.ICICI. 01/01/2010 661 . IDBI: Under the Project Finance scheme IDBI Bank provides finance to the corporates for projects in both rupee and foreign currencies for Greenfield projects as also for expansion. It also grants rupee loans and has a Merchant Banking Cell to give specialised services in project planning and formulation. IDBI ICICI: It has been specialising in providing term loans in foreign currencies. diversification and modernization.

01/01/2010 662 . seaports. railways and logistics as well as Special Economic Zones. including infrastructure projects. IDBI Bank has signed a Memorandum of Understanding (MoU) with LIC in December 2006 for undertaking joint and µtake-out¶ financing of long-gestation projects. telecom. IDBI Bank has been actively participating in structuring and financing of infrastructure projects in the areas of power. roads.IDBI IDBI Bank follows the Global Best Practices in project appraisal and monitoring and has a welldiversified industry portfolio.

The Bank is also a member of the Core Committee of the Government set up for finalisation of the Ultra Mega Power Projects (UMPPs). besides part-financing development of international airports and seaports under the Public-Private Partnership route. 01/01/2010 663 . IDBI Bank interacts with Government and other stakeholders and market participants.IDBI The Bank has also taken initiatives in funding modernization of airports. facilitating smooth flow of funds to infrastructure sector. on policy and operational issues.

GIC. It also augments the funds of the State level financing institutions by subscribing to their bonds. 01/01/2010 664 . ‡ UTI. IDBI has a Bill discounting scheme through which it provides refinance assistance to SSFCs.IDBI It operates Bill discounting and technical development fund schemes. LIC: They assist industrial projects by mainly participating in consortium arrangements for providing equity support and underwriting assistance and granting term loans. SIDCs and commercial banks.

‡ The State Level FIs are: SFCs and SIDCs. ‡ National small Industries Corporation (NSIC). SIDBI ‡ Industrial Investment Bank of India (IIBI) (Formerly Industrial Reconstruction Bank of India ±IRBI): It specialises in providing rehabilitation assistance to sick units. 01/01/2010 665 .IIBI. ‡ SIDBI: It takes care of the needs of the Small Scale and SME sector industries.

and building up innovative fee based business from asset management.com ) ‡ IDFC¶s mission is to be the financier of and advisor of choice for infrastructure in India.html and http://www. ‡ It is focussed on growing its balance sheet through project finance. see http://www.idfcpe. 01/01/2010 666 . Ltd.idfc. project development and advisory services.com/pages/main1.IDFC ‡ Infrastructure Development Finance Co. (IDFC): ‡ (For more details pl.

IDFC ‡ IDFC finances projects for electricity generation. ‡ solid waste management. 01/01/2010 667 . railways and pipelines). ‡ The other sectors financed by IDFC are in the urban infrastructure development urban transportation(-roads. as well as projects in the oil and gas industry. transmission and distribution. ports. ‡ industrial water supply. airports.

townships.new projects and acquisition finance for consolidation). IT parks.IDFC ‡ telecommunications (cellular. the IDFC funds the private sector entrepreneurs for projects in the above mentioned areas. whereby the GOI funds upto 20% of the project cost under the Public Private Partnership model. basic. ‡ tourism. and ‡ commercial and retail real estates ‡ Under the µviability gap funding¶ mechanism announced by the GOI. 01/01/2010 668 . SEZs. long distance and international and cable -.

2 billion. 57. IIFCL ‡ IDFCPE ( a 100% subsidiary of IDFC) was established in 2002.IDFC. is India¶s largest and most actives Private Equity focussed on infrastructure and is managing a corpus of Rs. ‡ India Infrastructure Finance Company Ltd (IIFCL) : ‡ Although there has been progress in attracting private investments into infrastructure. Gross Capital Formation (GCF) in infrastructure has hovered around 5 percent of Gross Domestic Product (GDP) 01/01/2010 669 .

India Infrastructure Finance Company Ltd (IIFCL) was established in January 2006 as a wholly owned Government of India company and commenced its operations from April 2006.IIFCL ‡ The 11th Five Year Plan (2007-2012) has envisaged raising the level of GCF in infrastructure to 9 percent of GDP by 2012 . ‡ Accordingly. 01/01/2010 670 . broadly referred to as SIFTI. ‡ Government of India. thereby matching the levels obtaining in some of the Asian economies. accordingly approved a Scheme for Financing Viable Infrastructure Projects through a Special Purpose Vehicle called the India Infrastructure Finance Company Ltd.

In order to be eligible for funding by IIFCL. the following will be the eligibility criteria: ‡ Eligibility ‡ The project shall be implemented by : hA Public Sector Company . any State government or a Public Sector Undertaking.IIFCL ‡ IIFCL shall finance only commercially viable infrastructure projects. 01/01/2010 671 . h A Private Sector Company selected under a Public-Private Partnership (PPP) initiative h a private sector company provided it has undertaken a project where the service to be provided is regulated or the project is being set up under an MoU arrangement with the Central.

airports. railways. water supply. solid waste management and other physical infrastructure in urban areas.IIFCL exceed 20% of the lending programme of the company in any accounting year h The tenor of IIFCL lending should be larger than that of the longest tenor commercial debt by at least two years. h Total lending for such private projects shall not . Gas pipelines Infrastructure projects in Special Economic Zones (SEZs) and International Convention Centres and other tourism 01/01/2010 672 infrastructure projects. Power. other transportation projects. inland waterways. seaports. Urban transport. sewage.h The project should be from one of the following sectors : Roads and bridges.

‡ Disbursement of loans by IIFCL is subject to the appraisal being done by reputed appraising institutions and the lead bank accepting and adopting the same. ‡ IIFCL would not normally carry out any independent appraisal of the project. ‡ IIFCL shall disburse the loan only after getting the sanction from the Lead Bank. 01/01/2010 673 .IIFCL ‡ Projects which are set up on ³non-recourse´ basis would only be eligible for financing by IIFCL.

Refinance to banks and financial institutions for loans with tenor of more than 10 years granted by them.IIFCL ‡ Lead Bank shall be responsible for regular monitoring and periodic evaluation of compliance of the project with the agreed milestones. ‡ Lending Terms: ‡ IIFCL may fund viable infrastructure projects through the following modes: ‡ Long term debt. 01/01/2010 674 . Any other mode approved by Government of India.

01/01/2010 675 .IIFCL ‡ Total lending to any project by IIFCL shall not exceed 20% of the total project cost subject to exposure of IIFCL being less than that of the lead bank. delivering an infrastructure service on payment of user charges. ‡ A PPP project has been defined under the Scheme as a project based on a contract or concession agreement between a government or a statutory entity on the one side and a private sector company on the other side. ‡ Lending to PPP projects ‡ A project awarded to private sector company through PPP shall be accorded priority for lending by IIFCL.

the private sector company shall be selected through a transparent and open competitive bidding process.IIFCL ‡ In case of PPP projects. 01/01/2010 676 . ‡ PPP projects based on standardized/model documents duly approved by the respective government would be preferred.

the wide range of categories of financial Assistance given by the all India FIs are: ‡  Rupee Term Loans. 677 and .  Underwriting of equity capital.  Foreign Currency Term Loans. Preference Capital. 01/01/2010 Risk Capital Assistance. Debentures and bonds.General: All India Financial Institutions ‡ In general.  Seed Capital Assistance.  Guaranteeing loans raised by industrial concerns from different sources including commercial banks and extending guarantees in respect of deferred payments by importers.  Operation of Technical Development Fund.  Soft Loan Schemes.  Lease Financing. Direct subscription to Capital.  Bill rediscounting.  Equipment Financing.

EXIM Bank ‡ The financial assistance provided by the State Level Corporations are: ‡  Term Loans. From identifying global opportunities. every step. Underwriting of shares and Direct subscription to capital.SFCs. ‡ Exim Bank : Backs up the exporter of Project exports. preparing competitive bids. 01/01/2010 678 . till the projects are successfully completed. to guarantees and financial support.

(More details are available in Exim Bank¶s website under Lines of Credit. transmission & distribution. and under the Lines of Credit to the foreign governments. under the Buyers¶ Credit to the buyer of Indian goods/projects. 01/01/2010 679 . oil exploration. FIs and banks.) The programmes of lending are under the Suppliers¶ Credit to the Indian Exporter. dams. tunnels.EXIM Bank From power generation. to supply of capital goods and consultancy services. the range is wide.

allied small-scale industries. implementation etc.NABARD ‡ NABARD extends credit to agriculture. It also refinances the commercial banks against their lending to these sectors. 01/01/2010 680 . It gives expert advice on projects formulation. and handicraft and allied activities. cottage and village industries. to the sponsors of projects in the above areas and also refinances banks which gives such project loans.

IFC ‡ International Finance Corporation (IFC). it also has: ‡ Developed innovative financial products ‡ Broadened its capacity to provide advisory services. Apart from Project Finance to companies in developing countries. constantly adjusting to the evolving needs of its clients in emerging markets. a member of the World Bank group: ‡ Products & Services: ‡ IFC is a dynamic organization. 01/01/2010 681 .International Financial Institutions.

Its financial products include: ‡ Loans for IFC's Account ‡ (IFC offers fixed and variable rate loans for its own account to private sector projects in developing countries.) ‡ Most A-loans are issued in leading currencies. These loans for IFC's own account are called A-loans. 01/01/2010 682 . but local currency loans can also be provided.IFC ‡ Financial Products: IFC continues to develop new financial tools that enable companies to manage risk and broaden their access to foreign and domestic capital markets.

‡ Grace periods and repayment schedules are determined on a case-by-case basis in accordance with the borrower's cash flow needs. ‡ Some loans have been extended to as long as 20 years. ‡ IFC operates on a commercial basis. 01/01/2010 683 . ‡ If warranted by the project. It invests exclusively in for-profit projects and charges market rates for its products and services.IFC ‡ The loans typically have maturities of 7 to 12 years at origination. IFC provides longerterm loans and longer grace periods.

35% in small projects. ‡ The Corporation also makes loans to intermediary banks. ‡ To ensure the participation of other private investors. and other financial institutions through credit-lines for further on-lending. A-loans are usually limited to 25% of the total estimated project costs for greenfield projects. or. leasing companies. on an exceptional basis.IFC ‡ Loans from IFC finance both greenfield companies and expansion projects in developing countries. ‡ The credit lines are often targeted at small and medium enterprises or at specific sectors. 01/01/2010 684 .

without recourse or with only limited recourse to the sponsors. A-loans range from $1 million to $100 million.IFC ‡ For expansion projects IFC may provide up to 50% of the project cost.) ‡ Syndicated Loans ‡ Equity Finance 01/01/2010 685 . ‡ The Corporation is willing to extend loans that are repaid only from the cash flow of the project. ‡ Generally. provided its investments do not exceed 25% of the total capitalization of the project company.

01/01/2010 686 .IFC ‡ Quasi-Equity Finance ‡ Equity & Debt Funds ‡ Structured Finance ‡ Risk Management Products ‡ Local Currency Financing ‡ Subnational Finance (Joint IFC-World Bank Subnational Finance Department : The Subnational Finance Department is a combined initiative of the World Bank and the International Finance Corporation.

transportation. wastewater management. and to improve their efficiency 01/01/2010 accountability as service providers. without sovereign guarantees. provinces. municipalities.) 687 and . On a selective basis it also provides financial support to nationally owned enterprises operating in natural monopoly infrastructure sectors. In all of its financings its primary objective is to strengthen the borrowers ability to deliver key infrastructure services such as water. gas and electricity. and their enterprises with financing and access to capital markets.IFC IFC provides states.

IFC ‡ Trade Finance ‡ Advisory Services: ‡ IFC offers a range of advisory services in support of private sector development in developing countries. ‡ The project cycle illustrates the stages a business idea goes through as it becomes an IFC-financed project. 01/01/2010 688 . ‡ IFC Project Cycle: IFC offers a wide variety of financial products to private sector projects in developing countries.

‡ After the initial contacts and a preliminary review. . an appraisal team consists of an investment officer with financial expertise and knowledge of the country in which the project is located. ‡ Project Appraisal ‡ Typically. and an environmental specialist. an engineer with the relevant technical 01/01/2010 689 expertise. IFC may request for a detailed feasibility study or business plan to determine whether or not to appraise the project.IFC ‡ Stages of the Project Cycle ‡ Application for IFC Financing ‡ A company or entrepreneur. seeking to establish a new venture or expand an existing enterprise can approach IFC directly. foreign or domestic.

IFC's legal department. financial. ‡ If financing of the project is approved at the department level. 01/01/2010 690 . holds extensive discussions with the project sponsors and evaluates the technical.IFC ‡ The team visits the site of the proposed project. economic and environmental aspects of the project. the team submits its recommendations to senior management of the relevant IFC department. ‡ After returning to headquarters. drafts appropriate documents. with assistance from outside counsel as appropriate.

‡ Public Notification ‡ Before the proposed investment is submitted to the IFC Board for review. the public is notified of the main elements of the project. 01/01/2010 691 . ‡ Board Review and Approval ‡ The project is submitted to IFC's Board of Directors. which reviews the proposed investment. ‡ Environmental review documents are also made available to the public.IFC ‡ Outstanding issues are negotiated with the company and other involved parties such as governments or financial institutions.

making a legal commitment. ‡ Disbursement of Funds ‡ Funds are disbursed under the terms of the legal commitment signed by all parties. IFC and the company will sign the deal. 01/01/2010 692 . ‡ Legal Commitment ‡ If the investment is approved by the Board. and if stipulations from earlier negotiations are fulfilled.IFC ‡ Resource Mobilization ‡ IFC seeks to mobilize additional finance by encouraging other institutions to make investments in the project.

and it sends field missions to visit the enterprise. IFC monitors its investments closely. including annual financial statements audited by independent public accountants. ‡ It also requires quarterly progress reports together with information on factors that might materially affect the enterprise in which it has invested.IFC ‡ Project Supervision ‡ Once funds have been disbursed. ‡ It consults periodically with management. 01/01/2010 693 .

ADB ‡ Closing ‡ When an investment is repaid in full. ‡ It also promotes and facilitates investment of public and private capital for economic and social development. ‡ Asian Development Bank (ADB): ‡ ADB extends loans and provides technical assistance to its developing member countries for a broad range of development projects and programs. IFC closes its books on the project. or when IFC exits an investment by selling its equity stake. 01/01/2010 694 .IFC.

01/01/2010 695 . ‡ Japanese Overseas Economic Cooperation Fund (OECF) : ‡ Assistance Scheme/Program: The OECF provides long-term.ADB. OECF ‡ A project information document (PID) is summary information on an ADB-assisted project. low interest loans and/or takes equity in significant private sector projects which are linked to the fulfillment of its objectives. ‡ Loans to and investments in Japanese corporations engaged in development projects in developing countries can also be made.

agriculture and education. 01/01/2010 696 . the process takes place in Japan and support from a Japanese partner is usually imperative.OECF ‡ Criteria : Any developing country can apply for assistance under OECF¶s many programs. transportation. While a Japanese partner is not mandatory. ‡ Priority will be given to the sectors of energy.

up to what extent.FIs¶ guidelines for funding projects: ‡ The FIs¶ general approach to project financing: The FI/Bank receiving an application from the project sponsor scrutinises the proposal from various angles as follows .to decide whether to commit funds to the project or not. if yes. periodicity of recovery of interest and principal etc.by examining the salient features such as the background and experience of the applicant. in what form. particularly in the line of activity. 01/01/2010 697 . timing of releasing the funds. ‡ Whether the project is acceptable .

01/01/2010 698 .FIs¶ guidelines for funding projects: ‡ The potential demand for the project. ‡ The Co¶s Memorandum and Articles of Association to ensure that : there are no clauses prejudicial to the lender¶s interest and no limitations have been placed on the Co¶s borrowing powers and operations. ‡ Whether the project is in keeping with the priorities if any laid down by the Government. ‡ A credit report from the co¶s existing bankers to ensure the creditworthiness of the borrower. ‡ The availability of the required inputs and utilities and other infrastructural facilities.

and the cos¶ financial involvement in them and the overall structure of the inter-corporate investments (the purpose of this is to study the effect of diversion of resources of the co. ‡ If any redeemable pref. whether the redemption reserves have been adequately built up.FIs¶ guidelines for funding projects: ‡ The line of activities and financial position of the associate/subsidiary concerns if any. shares or debentures are issued. 01/01/2010 699 . to its associates/subsidiaries).

including the preliminary/preoperative expenses and working capital margin requirements. etc. technical feasibility. cost of the project. 01/01/2010 700 . availability of construction /production facilities. detailing the itemised assets acquired/to be acquired. suppliers of the plant and machinery.) ‡ Estimates of the cost of the project.FIs¶ guidelines for funding projects: ‡ Particulars of the project along with the copy of the project report furnishing the details of the technology. manufacturing process. (Comments about the technical/financial collaborators.

PERT/CPM Chart. foreign currency loans if any. 01/01/2010 701 . etc. deferred payment guarantees. ‡ Project implementation schedule together with Bar Chart. indicating the extent of promoters¶ contribution. the composition of debt ± term loans. ‡ Working capital requirements at the peak level during the first year of operations after commencement of commercial production and the banking arrangements to be made for financing the WC requirements..FIs¶ guidelines for funding projects: ‡ Details of the proposed means of financing. quantum of share capital to be raised through public issue.

production. marketing and finance after commencement of commercial production. 01/01/2010 702 . the qualifications. experience and competence of the key personnel to be in charge of the implementation of the project during the construction period and the executives to be in charge of the functional areas of purchase. ‡ Demand projection based on the overall market prospects together with a copy of the market survey report.FIs¶ guidelines for funding projects: ‡ Organisational set up with the list of Board of Directors.

01/01/2010 703 . changes made and their implications on profit. comments about D/E ratio and the Current Ratio ± whether they are in acceptable range? ----D/E ratio < 2 and CR >1.33 ‡ Method of depreciation followed. cost of production and profitability. ‡ (Financial analysis : For an existing company.FIs¶ guidelines for funding projects: ‡ Estimates of sales. ‡ Projected Profit and Loss account and balance sheet for the operating years during the currency of the bank¶s term assistance.

‡ Pending law suits by and against the co.s¶ Income tax and sales tax assessments and provisions made for the current year.FIs¶ guidelines for funding projects: ‡ Revaluations of fixed assets made in the past and the quantum of revaluation reserves. ‡ Status of Co. ‡ History of past sickness or any defaults made in the past. 01/01/2010 704 . and their financial implications. ‡ Nature and purpose and quantum of contingent liabilities.

(Comments on the type of charges to be created. in the case of sureties be they the co¶s directors or third parties.) 01/01/2010 705 . their networth etc.FIs¶ guidelines for funding projects: ‡ Qualified remarks by the statutory auditors) ‡ Proposed repayment programme. ‡ Projected funds flow statement covering both the construction period and the subsequent operating years during the currency of the term loan. ‡ Details of the nature and value of securities offered.

etc. (Comments on the Industrial licence if any obtained by the co. duly supported by the statements such as P & L account and B/S for the past years.FIs¶ guidelines for funding projects: ‡ Consents from the Government and other authorities and any other relevant information. clearance for import of plant and machinery. present financial position etc. its past performance. clearance from environmental pollution angle. approval of collaboration/technical know-how agreement.) ‡ (In the case of the existing concerns) particulars regarding the history of the concern.. no objections from the local authorities. 01/01/2010 706 .

the institution visits the project site or the factory site (In the case of the existing units). ‡ After a thorough examination of the various aspects detailed above. 01/01/2010 707 .FIs¶ guidelines for funding projects: ‡ The Application in the standard format of the lending institution duly completed in all respects. signed by the authorised signatories and submitted will form the basis for the detailed appraisal of the project by the lending institution.

and new concern venturing to set up a new project will all be different. an existing concern setting up a new project. the approach for appraising the proposal of an existing concern going in for expansion or modernisation . size and scope.FIs¶ guidelines for funding projects: ‡ Each project is examined in proper perspective having regard to its natures. ‡ The ultimate objective of the lender¶s appraisal exercise is to ascertain the viability of a project with a view to ensuring the repayment of the loan with interest. For example. 01/01/2010 708 .

counterchecked through inter-firm inter-industry comparisons. 01/01/2010 709 . ‡ When the lender is confident of the success of the project after a thorough appraisal. depending upon the projected cash flows. ‡ creation of charges in favour of the lenders. along with the detailed list of terms and conditions/covenants.FIs¶ guidelines for funding projects: ‡ In the appraisal exercise. all the data/information should be checked and wherever possible. ‡ disbursement of the loans in stages as agreed between the lenders and the co. it issues a µSanction Letter¶ to the co.

more than one bank/institution may participate in the lending with a view to share the risk. ‡ The lead bank enlists the services of some other banks in sharing the lending based on the Information Memorandum. appoints one bank as the µlead bank¶ . and prepares an µInformation Memorandum¶. ‡ In such a case. 01/01/2010 710 . ‡ Depending on the size of the loan. ‡ This process is known as µSyndication¶.FIs¶ guidelines for funding projects: ‡ and monitoring of the progress of the project and recovery of the interest and principal. the co.

the amounts of principal and or interest not paid on due dates). till the project starts commercial production and then the repayments of the principal and interest due would begin at monthly. 01/01/2010 711 .FIs¶ guidelines for funding projects: ‡ For term loans. the lenders also charge a ³processing fee¶ of about 1% of the loan amount.e. the project manager has to correctly calculate the cash outflows on account of these dues. quarterly or half yearly intervals depending on the cash flows projected. There may be an initial repayment holiday. ‡ Since the lending institutions will charge penal interest on the µoverdue¶ amounts (i.

‡ Working Capital Advances: Used for financing the current assets. bar to undertake any new project until the dues are paid in full. payment of dividends with the permission of lenders etc. additional funds should be brought in by the promoters in case of overrun. ‡ In the pre-production stage. restrictions on transfer of shares of promoters to others.FIs¶ guidelines for funding projects: ‡ Usually the loan documents stipulate certain covenants such as: the board should have a nominee from the lenders. finance is given in the form of Cash Credit/Overdraft/Letter of 01/01/2010 712 Credit. .

can draw for its operations. is given in the form of a loan and interest is charged on the entire loan amount till it is repaid. ‡ In the case of loans. ‡ The operations are reviewed at the end of every year and then renewed for another year.FIs¶ guidelines for funding projects: ‡ Under the Cash Credit/Overdraft system. called the µlimit¶. 01/01/2010 713 . the bank fixes the maximum amount that the co. ‡ Interest is charged periodically on the actual amount utilised by the co. the limit amount assessed for working capital needs of the co.

sells its products. the co. ‡ LC is opened in favour of the supplier of the RM. some of whom avail some credit periods for repayment.FIs¶ guidelines for funding projects: ‡ In some cases. the bank pays the supplier. the supplier of RM may demand an LC in which case the bank gives the LC facility also to the co. and on receipt of the stipulated documents form the supplier. as part of the WC limits. The amount is then recovered by the bank from the co. raises bills on its customers. ‡ In the post production stage. 01/01/2010 714 .

Thus the cycle goes on. 01/01/2010 715 .FIs¶ guidelines for funding projects: ‡ The bank discounts such bills on the co.¶s debtors and credits the amount to the Cash Credit/Overdraft account. ‡ Some of the typical covenants the FIS/banks impose in their Sanction Letters: ‡ The bank/FI has the right to examine the books of accounts and inspect the co¶s factories at the co¶s cost.

FIs¶ guidelines for funding projects: ‡ During the currency of the loan:  the co. or expansion scheme.  should not enter into any borrowing arrangements with any other lender.  should not invest or lend to others other than normal trade credits. 01/01/2010 716 . should not alter the capital structure.  should not formulate any scheme of amalgamation/merger.  should not undertake any new project.

FIs¶ guidelines for funding projects:  should not declare dividends except out of profits.  should not create any charge on the assets of the co.  should not undertake any trading activity other than the sale of its products.  should not permit any transfer of the controlling interest or make any drastic change in the management set-up.  the bank will have the option of nominating a director on the board of the co.  should not repay the loans to its promoters/ directors/ friends /relatives without the written permission of the bank. in favour of any other FI/bank or persons. 01/01/2010 717 . etc.

01/01/2010 718 . ‡ For simplicity. as it has been facing earlier in its existing business. ‡ But in reality the risk in every project may be different ± for example.Risk Analysis ‡ Risk is inherent in capital budgeting decisions. as the benefits and costs will extend over a long period. the risk in a research project may be much more (due to uncertainty of the outcome) than an expansion project. so far it has been assumed that the firm would face the same risk in the new projects. ‡ Hence the average cost of capital was used for evaluating the new projects.

‡ If in a given situation. ‡ Risk is a situation. all the future events are known beforehand. 01/01/2010 719 . it is described as certainty. ‡ However. where the possible events are known. but which of those will actually happen is not known. ‡ Uncertainty the opposite condition is the situation in which the future events are not known.Risk Analysis ‡ Therefore the risk in each project has to be identified and measured separately so as to arrive at the correct conclusions. the probability of their occurrence can be determined.

‡ There are different techniques that are applicable for the µstand-alone¶ risk of a project and the risk that the project in the context of the firm. market risk and international risk.Risk Analysis ‡ Risk analysis is a complex area in Project. industry-specific risk. 01/01/2010 720 . ‡ Risks may be project-specific. measures and perspectives on risk: ‡ Risks can be broadly classified into two categories : Business risk and financial risk. competitive risk. All kinds of risk can be included in one of the these two risks. ‡ Sources.

‡ Competitive risk: Risk arises due to the unanticipated actions of the competitors. regulations that are specific to the industry to which the project belongs. These risks will affect the cash flow and hence the earnings of the project. ‡ Industry ±specific risk: arises due to changes in technology.Risk Analysis ‡ Project specific risk: the earnings and cash flows of the project may be lower than expected because of estimation errors or due to some other factors. 01/01/2010 721 .

‡ The more important measures of risk are range. inflation rate.Risk Analysis ‡ Market risk: arises due to changes in macroeconomic factors like fall in the GDP growth rate. 01/01/2010 722 . ‡ International risk: arises in the case of a foreign project due to changes in exchange rates or political conditions/decisions in the foreign country. affecting the cash flows and earnings of the project. coefficient of variation and semi-variance. standard deviation. interest rate.

20 0 60 0 0 0 ‡ ‡ ‡ W 0 . ‡ The W of the NPV distribution = 249.Risk Analysis ‡Le us ke n ex mp e exp n he me su es. 0 . 0 . The Range is 700 ½ Standard Deviation W = 7 { pi (xi ± xa)2} where = Standard Deviation.8. xa= expected value. xi = ith value . 01/01/2010 723 . pi = probability of the ith value.2 The weighted NPV works out to 540. ‡ Variance = W2 = 62.400.

if you compare two projects with expected NPVs Rs..46. ‡ The CV adjusts the SD for scale and is defined as: CV = SD/Expected value. ‡ So CV in the example = 249. comparison of SDs. 10 million and Rs. will give a decision that the second project should be selected.Risk Analysis ‡ Coefficient of variation (CV): Standard Deviation (SD) is expressed in absolute values and so by comparing the SDs you cannot conclude which of them is better. 90000/. 1 lakh and Rs. 1 million with SDs of Rs.8/540 = 0. ‡ For example. 01/01/2010 724 .

‡ SV = 7 pidi¶2. Since investors are concerned only about negative deviations. where di¶ = di when di < 0 . 01/01/2010 725 . ‡ So in our illustrative example. the Semi SD = the square root of the SV = 186. ‡ By extension. SV seems to be a more suitable measure of risk.2 in the example.Risk Analysis ‡ Semi Variance (SV) : SD considers all variances ± both positive and negative. SV = 34680.

its mean and SD contain all the information about its probability distribution. 01/01/2010 726 . ‡ (c) it is easily tractable.Risk Analysis ‡ SD and Variance are the most commonly used to measure risk. since: ‡ (a) SD has the same units as the original variable. and can be interpreted easily. If a variable is normally distributed. ‡ (b) SD is the measure of dispersion which characterises the normal distribution.

‡ But in real life. ‡ It may be possible to define the probability distribution with a high degree of objectivity. ‡ These are called µobjective¶ probability distribution.Risk Analysis ‡ Use of subjective probabilities: Probability distribution is required to measure the expected value and dispersion. such objective evidence may not be available for defining probability distributions. 01/01/2010 727 . on the basis of past evidence.

01/01/2010 728 . ‡ Perspectives on risk: Irrespective of the measure of risk used. This reflects the contribution of the project to the risk of a firm. Distribution. when it is viewed in isolation.Risk Analysis ‡ In such cases. the experience and judgment of some knowledgeable persons is pooled to define the Prob. ‡ These are µsubjective¶ probability distributions. there can be at least three perspectives and they are: ‡ Stand-alone risk: Represent the risk of a project. ‡ Firm risk: (Also known as Corporate Risk¶).

01/01/2010 729 . ‡ So the expected inflow in the second year is Rs.Risk Analysis ‡ Systematic risk: (also called the market risk). 30000 ± 25% . ‡ Certainty Equivalent method: This method is based on the utility of the decision maker. 20000 ± 75% and Rs. ‡ For example consider the scenarios of cash flows in a project and their probabilities in the second year : Rs. this represents the risk of a project from the point of view of a diversified investor. ‡ Methods of Risk Adjusted Investment appraisal: Let us see how to incorporate the risk factor into the investment appraisal. 22500.

‡ The cash flows are then discounted with the risk free rate of discount.Risk Analysis ‡ The Project Manager would rather prefer a certain outcome of Rs.44. 01/01/2010 730 . ‡ This method is useful when the risk-return perceptions of the project manager differ from year to year. as the risk adjustment has already been made. 22500 which is subject to some probabilities. ‡ First the certainty equivalents are calculated and then the certainty equivalents of cash flows are calculated. ‡ Here the Certainty Equivalent Co-efficient of the cash flows is worked out as: 10000/22500 = 0. 10000 rather than Rs.

higher is the confidence of the management on the forecasted cash flows. the CEC reduces for the later years as risk increases. and inflows in the first and second years would be Rs. the project cash outlay is Rs. 10 lakhs. ‡ We can see an example to see how the CEC is applied. and the risk free rate of discount is 8%. has cost of capital 10%.Risk Analysis ‡ 0 ” CEC ” 1. As a general rule. The project would have a life of two years and salvage would be negligible«««. 20 lakhs and Rs. The higher the CEC.. ‡ A co. 01/01/2010 731 . 25 lakhs.

10 = Rs. it was assumed that the risk characteristics of the new projects are the same as the investments already made by the firm.Risk Analysis «««The promoters¶ estimates of the CEC for the two years would be 0. Find the risk adjusted NPV of the project. ‡ In the simple NPV method.85)/1. ‡ Risk adjusted Discount Rate Method: Since different projects have different risk levels.79 lakhs. 01/01/2010 732 .85 and 0. (20000 *0.31.75.08 + (25000 * 0. the discount rates also have to be different to reflect the risks. ‡ NPV = Rs.082 .75)/1.

a. the premium for the normal risk of the firm u and the premium for the extra or below normal risk of the new project. i. 01/01/2010 733 . ‡ So the Risk Adjusted Discount (RAD) rate i¶ consists of three components : the risk free rate of discount r.e i¶ = r + u + a.Risk Analysis ‡ But in this approach. the new projects are discounted at the rate which incorporates the risk element of the new project.

1 30 .0 1 4 00 .4 00 .4 01/01/2010 Chosner to0 a fl wi a 1 s s r lit Aon oai mt u 00 .0 0 .2 2 .2 00 .0 30 .2 2 .0 00 .0 734 .1 3 .1 30 .4 20 .4 00 .3 2 .Consider the following example for understanding how the RAD is applied. nia ulo Choiner 1 it l tf w a fl w a to s s r lit Aon oai mt u 00 .

3. keeping in view the change in the risk factors.14 . However. ‡ NPV = . Expected cash flows in the years 6 to 10 (each) = Rs.255 ‡ In this example. ‡ Ans: Expected cash flows in each of the first five years = Rs. 2. the discount rate of 15% has been used for al the 10 years. 01/01/2010 735 .14 x PVIFA (15. different discount rates may be used for different years.14 + 2.5) = 0.5) x PVIF (15.5) + 3.54 x PVIFA (15.Risk Analysis ‡ The co¶s cost of capital is 13% and the extra premium required for the new project is 2%.54.

fluctuation in demand etc. non-availability of raw materials. n the expected NPV = 7 {At/(1+i)t} ± I .Risk Analysis ‡ Calculation of Standard Deviation of NPV-: ‡ Perfectly correlated cash flows are obtained when there are no factors that cause uncertainty such as competition. ‡ The behaviour of the cash flows in all periods is the same and they are linearly related to each other. i =1 01/01/2010 736 . ‡ In such cases.

Risk Analysis n and SD of the NPV = 7 Wt/(1+i)t i =1 i= 1 ‡ where At = expected cash flows. i = the risk free discount rate. t = life of the project and Wt = SD of the cash flows. 01/01/2010 737 .

Risk Analysis
‡ (See an example in ICFAI¶s Finance Series Vol II ±chapter 4: Pages 117 ± 118: Data is given about the mean cash flows for the number of years, the respective SDs, and the risk free interest rate is given. And so the working is quite simple.) ‡ Uncorrelated cash flows: When the firm operates in conditions of uncertainty, the cash flows cannot be correlated, i.e. In conditions of severe competition, heavy ad. expenditure etc. which make the cash flows of each year independent of the others.
01/01/2010

738

‡Here the formula for the NPV is the same but the formula for the SD changes to :
n

W (NPV) = { 7 Wt 2/(1+i)2t}1/2 i=1

01/01/2010

739

Quantitative aspects of projects PERT/CPM, Network analysis for monitoring of the project
‡ It is well known that management of any project involves the activities of planning, coordinating, monitoring, control and review of the performance of a number of inter-related tasks with limited resources. ‡ The Project Manager has also to be aware of the consequences of deviations from the initial plan ± like time overruns and cost overruns. ‡ Therefore they look for dependable devices to achieve proper control.
01/01/2010 740

Network Techniques
‡ Network techniques are primarily used in project management, particularly in dealing with non-repetitive operations. ‡ Network techniques provide the help a manager needs, when he is defining the complex relationship that exists in sequencing and time between many jobs and planned elements of work. ‡ During the actual execution of the project the slippages occur.

01/01/2010

741

Network Techniques
‡ Network is an arrow diagram, which is a graphic representation of the project plan. ‡ It depicts the logical sequence of the various elements for work, in relation to each other, that must be accomplished before a project can be completed. ‡ A network consists of µevents¶ and µactivities¶. ‡ Therefore it is necessary to divide the project into clearly defined major components and to recognise the µevents¶ that mark the start and completion of each µactivity¶. ( You may recall this is nothing but the WBS).
01/01/2010 742

Network Techniques
‡ An µevent¶ is an occurrence at a point in time marking the commencement or completion of one or more activities. ‡ The symbol for an event is a circle. ‡ Major events are marked by squares or rectangles. ‡ Events are numbered logically, starting from the µhead¶ events to the µtail¶ events and are inscribed inside the circle. ‡ An event is said to occur when all the activities leading to it are completed.
01/01/2010 743

Network Techniques
‡ To put in different words, an event is : (a) the start or completion of a task; (b) a significant point or milestone in a project and (c) consumes in itself no time or resources. ‡ An µactivity¶ represents a clearly defined project element, work, job or task, which forms an integral part of a project and needs time and resources for carrying out. ‡ There are examples of activities when no work is done but they occur in between two µevents¶««««
01/01/2010 744

Network Techniques
«..± for example curing time for concrete and involves only the passage of time, or waiting for a letter of sanction for loan from a bank . ‡ The symbol for an activity is an arrow ± the tail is the start of one activity from the previous µevent¶ and the head is the end of the activity, culminating at the next µevent¶. The length of an arrow does not represent the time taken by the activity.

01/01/2010

745

Network Techniques
‡ The basic rules for drawing a network are summarised below: ‡ Have a clear objective for which the network is required; ‡ Split the objective into broad areas of work (WBS); ‡ List the activities in a logical manner; ‡ Plot all the activities in the sequence as decided; ‡ Examine which activity has taken place, which is currently going on and which is the next;
01/01/2010 746

Network Techniques
‡ It has a single start event and a single final event; there cannot be any loops or danglers; all the paths of the network arse continuous and proceed from left to right; ‡ The network plan should have a time-table of work, with each job allocated a start and finish date to ensure that the resources required to execute the job will be available when needed. ‡ The time each job will take to be completed has to be estimated and noted against the job in the network diagram.
01/01/2010 747

Network Techniques
‡ Master networks: In large projects, it is desirable to prepare a number of separate networks-for each specific level of management which reflects the degree of detail and interest to that particular level or separate networks for each individual portions of the project. ‡ The network for the entire project is called the Master Network. ‡ The end events of each separate network are integrated and shown in the master network.

01/01/2010

748

Network Techniques
‡ A network is not completed until the project is completed. ‡ Advantages of network planning: ‡ It enables the break-up of the total project into sets of individual jobs or events and arranges them in a logical sequence; ‡ It estimates the duration and resource requirements of the individual job and hence facilitates the allocation of resources; ‡ It identifies the trouble spot in advance and pinpoints responsibilities;
01/01/2010 749

Network Techniques
‡ Since the executives of all the departments participate in drawing the network, their commitment is ensured to stick to the schedules; ‡ In case of any change in the management team, the subsequent team can easily carry on with the project with the help of the network analysis;

01/01/2010

750

Network Techniques
‡ It indicates the optimum start and finish times for each activity in an operation, and allows the operations that follow a set pattern to be partly pre-planned, speeding up the final planning; ‡ It is an important means of training the personnel in the techniques of handling the operations; ‡ It allows for multi-project scheduling by computer.

01/01/2010

751

PERT
‡ PERT: A new family of planning and techniques has helped the development of the defence, construction, chemical and other industries. ‡ Some of them are: PERT, PERT/Cost, PERT/Time, CPM, CPA (Critical Path Analysis), CPS (Critical Path Scheduling) GERT ( Graphical Evaluation and Review Technique) and PERT is the best known among these techniques. ‡ PERT was first introduced by the US Navy for its Polaris weapon system in 1958.
01/01/2010 752

PERT
‡ In India, large PSUs as well as Pvt. sector giants use PERT for their projects. ‡ The requisites of PERT are: ‡ The project goal needs to be clearly identified, visualised in a logical manner and are put in a network flow diagram, comprising events and activities; ‡ All activity paths need to be completed by appropriate events and a description of each activity needs to be written above the arrow linking the events;
01/01/2010 753

01/01/2010 754 .PERT ‡ Events and activities need to be sequenced so as to allow the determination of the critical paths. ‡ The PERT network analysis consists of the following steps: ‡ Clearly defining the goal of the project. and all constraints and inter-dependencies should be shown in the diagram.

PERT
‡ Preparing the WBS to a set of individual jobs and arranging them in a logical fashion; ‡ Estimating the job duration, making provisions for optimistic and pessimistic schedules; ‡ Identifying the resource requirement constraints; ‡ Locating the schedule of dates for each activity by planning a detailed control structure;

01/01/2010

755

PERT
‡ Preparing project control systems, and identifying the requirements of progress reports for different levels of management; ‡ Developing the critical path and slack times; ‡ Crashing the time ±optimum cost levels on the basis of costs; ‡ Updating the network continuously by systematised methods; ‡ Monitoring, evaluating and reviewing the network constantly.

01/01/2010

756

PERT
‡ Benefits of PERT: ‡ PERT gives management the ability to plan the best possible use of resources to achieve a given goal within the overall time and cost limitations; ‡ It helps the project manager to handle the uncertainties involved in programming where no standard time data are available; ‡ It utilises the time network analysis as a base method of approach to determine manpower, material, machinery and capital requirements.
01/01/2010 757

PERT
‡ It is an effective mechanism for planning, scheduling and co-ordinating the different activities in project buying. (Nowadays a PERT networks charts are a µmust¶ for every tender submissions to public sector projects); ‡ It is useful for annual shutdown and overhauls to identify the critical activities; ‡ It not only helps the management in deciding when to initiate the follow ± up and provide materials, but also gives an estimate of the consequences of not meeting such demands;
01/01/2010 758

PERT
‡ It enables the optimum utilisation of the resources by their transfer from the slack to busy segments in the network in order to accomplish the stipulated goal. ‡ PERT is one of the most important techniques of scientific management in project planning with the minimum possible scheduling time and use of resources. ‡ Inefficiencies in personnel loading can be removed by the proper use of slack activities, lead time can be analysed and hence work schedules can be expedited.
01/01/2010 759

PERT
‡ PERT network reveals the interdependencies and problem areas which are either not obvious, or not well defined by the conventional methods; ‡ PERT allows a large amount of data to be presented in a systematic orderly manner and keeps the management posted up to date by the principles of exception; ‡ PERT has been effectively used in many areas since it offers a trade-off relationship between time, cost and performance objectives on a scientific basis.
01/01/2010 760

PERT
‡ The kind of probabilistic approach adopted in PERT is useful in bidding for contracts by working out the expected performance based on experience. ‡ If individual activities are delayed, then the extension of time permitted can be computed. ‡ These computations help in the calculation of the tolerances for activity times in execution for selective management control.

01/01/2010

761

PERT
‡ Project duration and variation: ‡ Project network is concerned with the control of time. ‡ Hence the activity time or duration associated with each activity has to be estimated by experience, work measurement and intelligent guess. ‡ Three time estimates are made ± the optimistic to (hope that everything will go well without any hitch ± the minimum time ± a very low chance of realisation in reality),««««
01/01/2010 762

PERT ‡ ««.. the pessimistic tp (the assumption that everything will go wrong ± the maximum time ± a very low chance to occur in reality) , the most likely tm (not the average of to and tp but estimated from experience and intelligent guess) for each activity for the persons responsible for implementing the activity.

01/01/2010

763

PERT
‡ From these three time estimates, the expected time te is calculated by using the empirical formula: te = (to + 4 tm + tp )/6 ‡ Slack and critical activities: The expected µelapsed time¶ required to perform an activity in the network is based on the normal working conditions. ‡ After calculating the µexpected time¶ te for each activity, they are cumulated from the start till the end through the various paths.

01/01/2010

764

PERT
‡ The earliest project completion time T(E) is identified for each event as well as the final event in the PERT network. ‡ In computing the latest allowable time T(L),you have to work backward from the completion time for each event , and is obtained by subtracting the expected elapsed time estimate from the final goal and moving backwards through the various paths The chart is analysed by adding the estimated times. along each of the many paths, from beginning to the end of the job.
01/01/2010 765

PERT
‡ In forward pass, for converging activities in junctions, we take the largest value of T(E) ; while in the backward pass in the reverse direction, for converging values, we take the smallest value T(L). ‡ Thus for every event, there are two values T(E) and T(L). ‡ Wherever these two values coincide, the commencement of that activity cannot be postponed, without introducing delay in the completion of the project.
01/01/2010 766

PERT
‡ This is known as µslack¶. This positive difference gives the margin of time by which the commencement of an activity can be deliberately delayed without dislocating the duration of the project. ‡ The slack of an event is defined as the difference between the latest and the earliest available time to do a job and is also called the µfloat¶. ‡ The activities that fall on the events of zero slack trace the critical path.
01/01/2010 767

PERT
‡ IN SHORT,THE ALGORITHM FOR LOCATING CRITICAL ACTIVITIES IS TO OBTAIN T(E) AND T(L), AND THE ACTIVITIES WITH ZERO SLACK TIME. ‡ The events with zero slack are identified as critical events, and the path that passes through the critical events is the critical path. ‡ Critical path interpretation: Slack is associated with non-critical activities. In a network, the path having the least slack is the critical path. It is also the longest path which consumes maximum time.
01/01/2010 768

PERT
‡ As the name suggests, each activity in the µcritical path¶ is critical, since a delay in any of the events in this path will cause the entire project to fall behind schedule, unless additional resources and personnel are made available. ‡ By concentrating on the critical path, the Project Manager can transfer facilities from the slack path to the critical path, in order to minimise delays. ‡ Zero slack indicates that the project will be completed on schedule.
01/01/2010 769

PERT - CPM
‡ A positive slack indicates that the project will be completed ahead of schedule and a negative slack indicates that the event is likely to slip behind the scheduled date. ‡ See an example in Chapter 5, Pages 36 to 38 of the book PG. ‡ Critical Path Method: It is a mathematically ordered system of planning and scheduling for project management, which makes possible a balanced, optimum time cost schedule and assures timeliness and minimum use of resources.
01/01/2010 770

this method is also based on the network principle. scheduling and coordinating of its new Plant construction. while an activity represents the time and resources required to progress from one event to another. ‡ An event represents a specified programme accomplishment at a point in time. ‡ Like the PERT.CPM ‡ The method was first used by Du Pont to improve the planning . 01/01/2010 771 .

CPM ‡ After the network diagram is established. ‡ With the normal estimate. 01/01/2010 772 . the time and cost estimates are applied to each activity. ‡ As attempts will be made to reduce it later. normal time is considered as the maximum time. the prime consideration is minimum cost with the associated time. ‡ But the costs associated with normal times are assumed to the minimum costs.

01/01/2010 773 .CPM ‡ The µcrash¶ estimate is defined as the absolute minimum time and the associated cost in relation the maximum cost. ‡ PERT uses three time estimates to arrive at the µexpected time¶ of each activity. ‡ The CPM user is assumed to be on less uncertain ground and to have had some prior experience with the activities comprising the project. ‡ It is assumed that linear cost relation exists between normal and crash estimates for each activity.

01/01/2010 774 .CPM ‡ The estimates of normal and crash times are assumed to be quite specific and made with a fair degree of confidence. ‡ Similarly the cost estimates are also assumed to be based on a fair degree of definiteness and confidence based on prior experience.

CPM Networks are µActivity¶ oriented ± emphasises the description associated with the activities in a network. 775 . If the most likely time is known. A deterministic model ± cost conscious Particularly useful where the decision variables can be predicted with reasonable accuracies as in construction projects. The time for one or more activities follow a probability distribution. then it may be used a deterministic value 01/01/2010 PERT Networks are µEvent¶ oriented A model under Risk ± concerned with time. takes into account the uncertainties.

known as tasks. 01/01/2010 776 . ‡ For each task. determine the activities and events to be performed.CPM ‡ Assumptions of PERT and CPM: ‡ Both assume that the project is definable by activities that have distinct beginning and ending points. ‡ Construction of CPM: The basic steps involved are: ‡ Break the entire project into smaller systems.

CPM ‡ For each activity. determine the time and other resources needed. determine the preceding and succeeding activities. Events are represented by circles called µ nodes¶. considering only the expected time estimate. ‡ For each activity. ‡ Draw a network plan depicting the assembly as discussed in the previous chapter. 01/01/2010 777 .

‡ The earliest occurrence time of the initial event is set to zero. ‡ An event can occur only once. and we proceed through the diagram . ‡ The time flow is from left to right.CPM ‡ Ground rules for construction of the CPM are: An event cannot occur until all the activities leading to it are completed and an activity cannot start until its preceding event has occurred. 01/01/2010 778 .

01/01/2010 779 . the earliest and latest occurrence times are plotted in the chart. ‡ An activity can start only when all the preceding activities have been completed. ‡ Therefore.CPM ‡ The earliest occurrence time can be calculated only if the preceding events¶ earliest occurrence times are calculated. the earliest occurrence time of an activity is precisely the earliest occurrence of the predecessor event. ‡ The arrow diagram is common to both PERT and CPM. THE DIFFERENCE LIES IN THE DATA ENTERED ON THE DIAGRAM.

01/01/2010 780 . ‡ Thus the latest start times of activities are the finish times of activities which require the greatest normal time.CPM ‡ The start time of an activity plus its activity duration gives its finish time. a later finish would delay the project ‡ The finish time of an activity minus its activity duration gives its start time. the earliest finish times of activities are the earliest start times of the activities plus their duration. ‡ The latest finish time of an activity is precisely the latest occurrence time of its successor event. ‡ Thus.

earliest start dates are computed for all activities along any path by working forward from the beginning of the path activity in the path. ‡ Based on the normal times for each activity.CPM ‡ The critical path is that sequence of activities which require the greatest normal time to accomplish. 01/01/2010 781 . ‡ Similarly. the latest finish date and earliest finish date for all activities in a given path are computed.

01/01/2010 782 . ‡ Events with zero slack are known as critical events and the path that traverses through critical events is the critical path. ‡ Non critical activities can be increased in duration.CPM ‡ It may be mentioned that sufficient leeway is possible for any path other than critical. since there is time to spare to complete these activities but without exceeding the critical path time.

‡ THE FLOAT OF THE ACTIVITIES IS THE DIFFERENCE BETWEEN EITHER THE LATEST START AND EARLIEST START OR BETWEEN THE LATEST FINISH AND THE EARLIEST FINISH. 01/01/2010 783 .CPM ‡ Float calculation: µFree Float¶ is the maximum time slippage of an activity that can be tolerated without affecting the completion date of any other activity in the situation where both the preceding and succeeding activities are assumed to start at the earliest possible times.

‡ Here the assumption is that all the preceding activities start as early as possible and all succeeding activities start as late as possible.CPM ‡ The µTotal Float¶ is the maximum slippage of an activity or the spare time that can be tolerated without affecting the completion date of the overall project. 01/01/2010 784 . ‡ THE DIFFERENCE BETWEEN THE START AND COMPLETE EVENTS OF THE ACTIVITIES IS THE TOTAL FLOAT.

or the float available to preceding activities.CPM ‡ µIndependent Float¶ is the maximum slippage of an activity that can be tolerated without affecting the latest completion date of any other activity under the situation where all preceding activities are completed as late as possible and all succeeding activities are started as early as possible. 01/01/2010 785 . ‡ The duration of an activity with independent float can be increased by the amount of float without affecting the progress of the succeeding activities.

Free float occurs only in the last of a series of activities leading to a critical path.CPM ‡ IT IS CALCULATED BY DEDUCTING THE LATEST EVENT TIME OF START EVENT AND DURATION OF ACTIVITY FROM THE EARLIEST EVENT TIME AND END EVENT FOR ANY ACTIVITY. ‡ This will reduce the amount of total float available for preceding activities. ‡ Free Float is the duration by which the float of an activity can be increased without affecting the progress of succeeding activities. 01/01/2010 786 .

‡ Total duration of the project can be reduced only by reducing the duration of the activities on the critical path. 01/01/2010 787 . provided the activities are interchangeable. thereby releasing some of the resources for use in the critical activities.CPM ‡ Critical Path and Management Decisions: ‡ The activities for which positive slack time is available can be performed at a slower pace.

change. the entire network may have to be reconstructed and the new path of critical activities identified. ‡ Total Float ={T(L) of succeeding event minus T(E) of the preceding event} ± t(e). 01/01/2010 788 . ‡ Slack is the difference between the latest event time and the earliest event time for a particular event.CPM ‡ When a project network is executed and one or more time estimates. ‡ Free Float ={T(E) of succeeding event minus T(E) of the preceding event} ± t(e).

01/01/2010 789 . ‡ Where t(e) is the µExpected Activity Time¶. T(L) is the µLatest Event Time ( (latest possible time at which an activity can start ) ‡ ³Interference Float¶ is the difference between total float and free float. (If negative.).CPM ‡ Independent Float = {T(E) of succeeding event minus T(L) of preceding event}. the Independent Float is taken as zero.t(e) . T(E) is the µEarliest Event Time (the earliest time an event can occur).

CPM ‡ µResource Levelling¶ is the scheduling of activity start times such that resource levels are kept at the minimum possible. such that the targeted project duration is maintained and fluctuation in resource requirements are minimised. 01/01/2010 790 . ‡ ³Resource Smoothing¶ is the scheduling of activity start times within the limits of their total floats.

‡ µActivity Crash Time¶ is the revised and reduced activity time. ‡ µCrash Cost¶ is the increase cost of crashing a project. 01/01/2010 791 . ‡ This is also known as µactivity compression¶.CPM ‡ µCrashing¶ is the process of advancing the completion date of the project to suit a revised and reduced project duration by reducing the duration of one or more activities on critical path.

CPM ‡ µCost Slope¶ is the additional cost to be incurred in reducing an activity time per unit time. 01/01/2010 792 . it would be necessary to have a re-look at the network. ‡ Compression on Critical Path: ‡ Need for crashing: The duration for the project completion as planned by the project manager may be more than that stipulated by the management. In that case.

CPM ‡ The time-cost trade-off or crashing the network is directed to the cost of determining a schedule of project activities which considers adequately the indirect as well as the direct costs. 01/01/2010 793 . ‡ The total time can be reduced by µcrashing¶. µcompressing¶ or µcompleting¶ the critical activities in less time. ‡ Obviously this will involve a higher cost than would be incurred when performing at the original rate.

as a last resort.CPM ‡ Compression is achieved by: ‡ Closer examination of the time estimates of the critical activities. 01/01/2010 794 .e. more concurrent activities and or changing or lowering performance requirements of certain activities. ‡ Dropping off low priority activities. ‡ Introducing greater paralleling i.

from non critical activities to activities on the critical oath. ‡ It should be noted that time and cost are inversely correlated. any activity will have a minimum time requirement. below which it cannot be reduced further. ‡ Addition of more resources to the critical path. and crashing other activities.CPM ‡ Transfer or reallocation of slack resources if possible. ‡ Due to technological constraints. 01/01/2010 795 .

the time required can be reduced by deploying additional resources/money. In between these two limits. ‡ The activity will have a normal time requirement. 01/01/2010 796 . ‡ This procedure is known as µcrashing¶ and the extra cost incurred is the µcrashing cost¶. duration of construction activity cannot be reduced below a certain limit due to constraints like time taken for curing of concrete etc.CPM ‡ For example.

‡ After a few such steps of crashing. ‡ The activity with the lowest slope is chosen for crashing.CPM ‡ The usual practice is to crash the initial activities on the critical path. 01/01/2010 797 . indirect and opportunity cost are included in the total cost. ‡ The additional cost and benefit have to be reviewed at each stage of crashing-direct. ‡ This implies that a new schedule with increased cost but with less time is obtained. more than one path may be come critical.

01/01/2010 798 .CPM ‡ The opportunity cost is the penalty for not accomplishing the job in time.Normal Cost)/(Crash time ± Normal time). = cost slope. ‡ The extra cost per unit of time = (Crash Cost.

‡ The time ± cost relationship helps the manager to determine when diminishing returns make further time saving uneconomical. 01/01/2010 799 .CPM ‡ Looking though the critical path and the cost slope. it is worthwhile crashing the activities. the activity with the smallest slope has to be crashed. but also quite often the total cost itself. ‡ As long as the extra cost incurred in crashing is commensurate with benefits. and thereby reducing not only the time of the project without incurring a total extra cost.

5 10 8 14 24 15 2 3 2 800 .5 5 2 8.o 01/01/2010 a b c d e f 1±2 1±3 2±4 3±4 2±5 3-5 9 6 1 4 10 1 Most Likely Pessimistic Average tm tp te = (to + 4tm + tp)/6 12 21 13 12 18 12 1.

2 13 1 2 12 2 8 01/01/2010 15 5 3 4 801 .

01/01/2010 2 1 2 8 2 0 1 2 1 0 2 8 2 1 8 1 0 0 0 0 802 .

‡ The minimum required time to complete the project is the duration of the critical path which is 28.CPM ‡ The paths 2 ± 4 and 1 ± 3 are slack paths each having a slack of 6 and so cushion. ‡ The path 1 ± 2 -5 which does not have any slack is the critical path. 01/01/2010 803 .

/ 2 ± 13/13 1 ±0/0 13 2 2 3 ± 12/18 01/01/2010 15 5 ± 28/28 12 8 4 ± 20/26 804 .

‡ The Free float : = EOT (4) ± EOT ( 2) . the Total float : = LOT (4) ± EOT(2) ± te (2-4) = 26 ± 13 -2 = 11.CPM ‡ Activity Floats: Once you know the activity times and the event slacks. ‡ In the above example. activity floats can be calculated. for the activity 2 ± 4. 01/01/2010 805 .te (2-4) = 20 ± 13 ± 2 = 5.

(Activities 1 ± 2 and 2 ± 5 in the above example.CPM ‡ And the Independent float:= EOT (4) ± LOT (2) te (2-4) = 20 -13 ± 2 = 11. 0 and -6. ‡ Similarly the total. free and independent floats for the activity 3 -4 are: 6.) 01/01/2010 806 . ‡ Similarly the floats for the other activities can also be found out. ‡ You will observe that all the floats are zeroes for the activities along the critical path.

the independent float of an activity may be negative but the total float and free float cannot be negative. 01/01/2010 807 . ‡ However. it means that the activity has a cushion irrespective of what happens elsewhere. ‡ Hence when an activity has a positive independent float.CPM ‡ The independent float represents the float under the most adverse conditions.

‡ The steps involved calculating the SD of the duration of critical path are as follows: ‡ Determine the SD of the duration of each activity on the critical path.CPM ‡ Measures of variability: ‡ Variability in PERT analysis is measured by variance or SD. 01/01/2010 808 . ‡ Determine the SD of the total duration of the critical path on the basis of info obtained in the previous step.

tm and tp. to. 01/01/2010 809 . In PERT analysis a simplified formula for Standard Deviation is used which is : W = (tp .to)/6.CPM ‡ For determining the SD of the duration of an activity. we require the entire probability distribution of the activity distribution. But we have only three values from this distribution viz.

Thus we have found that the mean and SD of the duration of the activities on the 01/01/2010 810 critical path are 28 days and 3.07 days.43 2 Variance of the critical path duration = Sum of variances of activity durations on the critical path = 9.W and variance of the activities along the critical path are as follows: Activity 1±2 2±5 tp 21 24 to 9 10 W = (tp . Variance = W 2 2.43 = 3. SD of the critical path duration = 9.to)/6.07.33 4 5. .43.

is symmetric. which have a large number of activities on the critical path. ‡ A normal distribution looks like a bell shaped curve. is single peaked and is fully described by its mean and SD. 01/01/2010 811 .CPM ‡ For real life projects. we can reasonably assume that the critical path duration is approximately normally distributed. with the mean and SD obtained as shown earlier.

and Three SDs : Mean 0.998.682. Mean Two SDs: :0. 01/01/2010 812 .CPM ‡ The probability of values lying within certain ranges is as follows: ‡ Range: Mean One SD : Probability : 0.954.

CPM ‡ Probability of completion of a project by a specific date: ‡ If we have the mean (T). which is normally distributed. where Z represents the no. of SDs by which D. 01/01/2010 813 . the specified date exceeds T. we can compute the probability of completion by a specified date (D) as follows: ± Find Z = (D ± T) / W. ± Obtain cumulative probability up to Z by looking at the probability distribution of the standard normal variate. and SD W for critical path duration.

CPM ± (Determining Z is equivalent to converting our specific normal distribution into standard normal distribution. ± The mean and SD of standard normal distribution are 0 and 1 respectively.) 01/01/2010 814 .

6 02/0 (25 -28)/.726 815 .005 0.07 0.25 02 0 W 2 0 25 30 01/01/2010 2 8 -2.159 0.07 -1.0 (30 -28)/3.6 0.

) Activities of a project can be expedited by crashing which involves employing more resources. and decreases indirect costs. managerial services«. 01/01/2010 816 . direct labour«)and indirect costs ( Overhead items like indirect supplies. etc..CPM ‡ Crashing of cost in CPM: ‡ CPM analysis assumes that The costs associated with the project can be divided into direct costs (direct material. rent insurance. Crashing reduces time but increases direct costs because of factors like overtime payments.

‡ Examine the cost ±time slope of activities on the critical path and crash the activity which has the lest slope. ‡ Repeat the two previous steps till activities on the critical path are crashed. ‡ Construct the new critical path after crashing as above and determine project duration and cost. ‡ The procedure for this as follows: ‡ Obtain the critical path in the normal network and determine the project duration and direct cost. 01/01/2010 817 .CPM ‡ The CPM analysis seeks to find ways of crashing on total cost (= direct costs + indirect costs) and also reduce the project duration.

Activity 1 2 1 2 2 Time in weeks Normal Crash 8 Cost Normal Rs. per week 0 2000 00 00 1000 2 00 00 00 1200 818 01/01/2010 . 000 000 000 2000 8000 10000 000 000 200 200 000 8000 00 200 12000 11200 800 8 00 000 0 00 1 2½ 2 10 Cost to expedite. Crash Rs.

2 8 9 3 10 6 5 1 5 9 7 1 2 0 819 01/01/2010 20 0 .

2 2 2 8 1 5 7 01/01/2010 6 3 10 5 6 9 0 0 820 .

1 2 00 2800 2 2 8 1 5 7 01/01/2010 2 00 6 3 10 5 2 9 821 .

12 00 1 2 2 2 000 2 00 2 4 1 5 01/01/2010 6 3 10 5 2 9 7 822 .

1 3 2 00 1200 3 3 00 2 2 22 2 4 1 5 01/01/2010 6 3 10 5 2 9 3 5 823 .

1 2 4 00 20 2 00 400 2 2 4 1 5 6 4 3 7 5 2 9 5 01/01/2010 824 .

5 7 5 2 9 5 5 825 .1 2 5 00 1 20 1200 5 00 2 4 1 5 01/01/2010 6 2.

‡ In the final analysis. 01/01/2010 826 . 60000). where the path 1 ± 2 ± 4 ± 6 ± 7 continues to be the critical path with duration 19 weeks and direct cost Rs. 39000 (from Rs. ‡ You may observe that there is no more activity left for crashing.5 weeks. the duration has come to 19.CPM ‡ We have now reached the final stage. due to crashing of some activities along the critical paths. 57600 and the indirect cost has come down to Rs. the direct cost has gone up to Rs. 57600.

57600 + 39000 = Rs. 105200 .e.CPM ‡ So the total cost has come down to Rs. 45200 + 60000 i. 01/01/2010 827 . 96600 ( from Rs.

lapses go easily go unnoticed and as a result. ‡ A lot of µApplication Packages¶ have also been developed. ‡ A lot of work has taken place on computer software. which are generally complex. The softwares that are available nowadays are user friendly . It has revolutionised the working of the industrial and project management all over the world. wrong decisions are made. 01/01/2010 828 . ‡ A number of computer µlanguages¶ have been developed based on the needs of the users. ‡ In projects.Computer Applications in Project Management ‡ The computer has now become a part of project decision-making process.

they have to seek the probabilistic approaches. Communication of the project strategy can be common with one control document seen by all. the computer cost will be equal to the manual cost. ‡ Project managers have to deal with uncertainties and risks while scheduling activities and allocating resources. versatility. accuracy and other facilities will far outweigh the manual process. reliability. Computer Applications in Project Management ‡ On any project with many activities. Memory. with frequent updating. In such cases. 01/01/2010 829 . but the speed.‡ Computers can help to avoid such pitfalls in all fields of management.

by doing the routine numerical problems at great speed.Computer Applications in Project Management ‡ For example. should be considered. ‡ Similar is the case with certain milestone events where probabilistic branching of certain activities to reach such events. 01/01/2010 830 . ‡ The Computer can aid the project management by providing quick analysed info in any required form. the probabilistic aspect of criticalpath methods deals with the fact that the actual duration of a project activity is usually a random variable rather than a deterministic constant.

slack. bar charts of various departments. activity timings. activity schedules. optimum time/cost. critical path. critical events. multi project schedules. bills outstanding. marketing info. allocation of resources. simulated PERT. in addition to the routine info about the activities. location of equipment. financial info. key activities. key ratios etc. 01/01/2010 831 . the computer can give detailed info about : critical activities. earliest and latest start and finishing times of activities.Computer Applications in Project Management ‡ In project management.

abundant project management software packages are now available. human resources. ‡ After the microcomputers have been widely adopted by the business community. costs and communications. contents of a project. ‡ The software programmes support the planning and control of such elements as work scope. budgeting. project timing.Computer Applications in Project Management ‡ The revolution in computer has made project management systems affordable and amenable to projects of all sizes. 01/01/2010 832 . They also compare the current status to the plan and so helpful in monitoring the progress of the project and its evaluation.

to plot the expenditure schedules and cash flow plans. ‡ The computer can support the project manager to support the budgets task by task or by cost categories.Computer Applications in Project Management ‡ Most of the WBS in project planning is now down by the computer. one can reorganise the activities. ‡ Tracking through the computer enables the recording of how much work has been done. reschedule the tasks and do resource planning in an iterative process to optimise the schedule and resource plan. ‡ With the help of computers. what resources were utilised and what costs were incurred. 01/01/2010 833 .

symbolic inference. ‡ An expert system is software that attempts to reproduce the performance of one or more human experts. 01/01/2010 834 . ‡ A new area of AI which is of particular interest to project management is known as µExpert System¶.Computer Applications in Project Management ‡ Artificial intelligence Expert System: ‡ Artificial Intelligence (AI) programmes involve symbolic representation. most commonly in a specific problem domain. and heuristic search. and is a traditional application and/or subfield of artificial intelligence.

‡ It could perform the following functions: ‡ Monitor deviations from the planned schedule.Computer Applications in Project Management ‡ These programmes seek to solve practical problems by imitating the process human experts would follow. ‡ They can achieve a high level of performance in tasks where human beings require years of special education and experience. ‡ An expert system is also capable of drawing conclusions without a predefined structure. 01/01/2010 835 . progress and analyse interrelations among the various packages.

identify the affected items and classify them in order of criticality.Computer Applications in Project Management ‡ Identify single potential schedule slippages. ‡ Pinpoint the needs for human intervention and analysis. The system would extrapolate effects of changes in status. ‡ The AI based system would attempt to take decisions on the basis of incomplete data. 01/01/2010 836 . but the expert system would identify the need for data and show where human intervention would be most effective.

which should be relieved from the earlier imposed management pressures or extra resources. (A delay in one would increase the cost of a later one. 01/01/2010 837 .Computer Applications in Project Management ‡ Show where to allocate special resources and reserves.) ‡ Improve resource utilisation. ‡ The system would extend schedule findings to cost-to-complete by tracking cost factors associated with work-packages. ‡ The system would not only focus on the most critical activities but would also point out previously critical activities.

time and returns. computers are very helpful in scheduling and allocating the resources among the projects since the resources may be drawn from the same common pool. equipment. The resources in question may be skilled manpower. funds etc. ‡ Optimisation of the utilisation of resources is achieved through the use of computers. 01/01/2010 838 .Computer Applications in Project Management ‡ Alternative resource schedules would be proposed automatically and presented to the management for decision. staff. which have to be managed along many dimensions such as costs. ‡ Multi-Project Scheduling: When several projects are progressing simultaneously.

Computer Applications in Project Management ‡ Global projects. supplier. coordination. ‡ Computer PERT simulation: ‡ Simulation is very helpful in Project Management especially in project planning through network analysis for new product launching. local project authorities. control. contractor. evaluation and integrate the same from the organisation¶s priorities. planning. organised on a matrix basis can be simulated to study the behaviour of client. 01/01/2010 839 . local regulations. consultant. architect. fund availability. monitoring. vendor. subcontractor.

‡ Simulation can be used for evaluating capital investment proposals by varying factors such as market size. The desired changes in system can be introduced for studying their effects. operating cost. fixed cost. useful life of facilities etc.Computer Applications in Project Management ‡ Simulation is a quantitative technique used for studying alternative course of action by building a model of that system and then conducting a series of repeated trials to predict the behaviour of a system over a period of time. 01/01/2010 840 . market growth rate. investment required. residual value of investment. selling price. market share.

01/01/2010 841 . Random numbers generated by the computer. which have equal chance of representation in the sample are used to simulate a sample. each time randomly selecting an activity time from within its estimated ranges for each activity.Computer Applications in Project Management ‡ By simulating the network several times. ‡ The accuracy of PERT simulation is more than that of PERT. simulation enables the probability of an activity being on critical path in advance and this helps in allocating the resources in a better fashion.

01/01/2010 842 .Computer Applications in Project Management ‡ Project Managers are often faced with considerable project uncertainties and risks and they arise due to external factors (such as government regulations. Network models provide the means to model these types of uncertainties.). difficulties in financing etc. design alternatives etc. ‡ There are also other constraints like technological considerations.) and internal factors ( site-location problems.

01/01/2010 843 . and SLAM provide the concepts of probabilistic and conditional branching.Computer Applications in Project Management ‡ In particular. the computer network simulation languages such as Q-GERT. ‡ This represents a significant modelling improvement beyond the capabilities of PERT and CPM type networks. random activity times. and different nodal release requirements for this purpose.

each with varying approach of performing certain basic functions of project planning. PCProjaks. scheduling. 01/01/2010 844 .Computer Applications in Project Management ‡ Project Management Softwares: ‡ These are used in time critical allocations. ‡ Now there are many project management software packages available in India ± some of the well known are :PRISM. monitoring. INSTAPLAN. Quick Net. Harward Total Project Manager. Proman. A multiplicity of project management software is available today . control and review.

‡ At least 25 names of Project Softwares have been listed in Wikipedia. plantrak.Computer Applications in Project Management ‡ There are also other packages such as: Artemis project. Microtrak. super project expert. MAC project. PROB-PERt. PERT master. ‡ (See the information about some of the softwares presently available in the Notes) 01/01/2010 845 . primavision. etc. ‡ Infogoal. plotrak. promis. timeline.com has the list of more than 400 Project Management Softwares.

You're Reading a Free Preview

Download
scribd
/*********** DO NOT ALTER ANYTHING BELOW THIS LINE ! ************/ var s_code=s.t();if(s_code)document.write(s_code)//-->