Sikkim Manipal University Financing & Budgeting PM0003

Project

PROJECT FINANCING & BUDGETING - PM0003 MBA SEMESTER 3 ASSIGNMENT (SET – 1)
Q1. Detail the top down and bottom up approach of cost estimation Ans: There are three main cost estimating approaches which can be summarized as 1. Top-down, 2. Bottom-up, and 3. Sideways (comparative). Top Down Top-down estimating takes a description of the needs/requirements (the ‘top’) and produces directly an estimate of the effort/material or cost to achieve the solution. For example to estimate the cost of a new office building you might decide the floor area needed, based on the number/size of rooms wanted and multiply that by a construction cost per square meter to arrive at the estimated building cost. This approach can sometime used to estimate the cost of IT projects if: • The size and complexity of requirements can be described in a quantifiable way • There is a recognized formula to translate requirements into effort or cost.

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The most common technique is based on Function Points, a measure of the amount of functionality or complexity in a system requirement. A formula translates this into effort based on a number of driving parameters. Whilst the approach appears scientific, the formula is often empirical (i.e. without any (analytical basis) and the parameters require subjective judgments such as degree of complexity). Once a total effort or cost estimate is obtained this can be partitioned using typical proportions. For a software development project typical proportions are Requirements 20%, Design 20%, Development 40%, Test 20%. If you do this remember everything is driven by the original estimate and partitioning is not improving that estimate. The top-down technique is useful in the early stages of a project to provide indicative estimates, once requirements have been captured. It goes directly from requirement to solution, so estimates are quick to produce, little design work is needed and the formula based approach facilitates what-if analysis. The technique can only be used however if a proven algorithm is available, is highly sensitive to the

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parameters used and gives no insight into the solution needed. Bottom Up Bottom up estimating involves taking the requirements, producing an initial design, identifying the work (and materials) needed to realize each component in the design (the ‘bottom’) then summing these up. Using the previous example, to estimate the labour cost of the new office building, identify all the work components (build walls, paint walls, fit windows etc.) work out a cost for each one and sum them to get a total cost. The design can be broken down to increasing levels of detail to improve confidence. There is no rule on how far to go; more effort is needed to develop a detailed design but this yields more information resulting in a more accurate estimate. The bottom-up technique can be applied in almost any situation, the basis of the estimate is clear and can be refined to clarify uncertainties or increase accuracy.

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The main disadvantages are that it requires the design to be available and it needs the most information and effort to produce. Q2. Explain the various key determinants of Cost: Ans: No two infrastructure projects will cost the same amount of money no matter how similar they are. Apart from basis technical factors, the wide range of how economic and institutional conditions in different Member States will itself always lead to variations. Nevertheless, the fundamental project costs are based on the actual cost of the land, materials, equipment and labor in the region where the project is being procured. These basic costs will vary depending upon a number of factors which are discussed below.
KEY DETERMINANTS OF COSTS

The Project Specifications:

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The specifications define the physical attributes of a project. With a road, for e.g., given levels of forecast traffic will lead to specification of the required length, depth and width of the road pavement, the material to be used for surfacing, the number of lanes, bridges and junctions etc. for buildings, the required function and expected occupancy rate will lead to a specification of total floor space and floor plate size, height , internal and external appearance, floor loading, heating and lighting requirements etc. Generally, the more detailed the specification and the larger the project, the more expensive it will be. Location: Location affects project costing via institutional factors and through geographical realities. Institutional factors can affect initial project cost estimates in a number of ways. Consents procedures in particular may be more arduous in some countries affecting the time in will take to successfully implement a project. Allowance for the costs involved in sustaining a long public consultation exercise in an example. Where major projects are likely to be strongly opposed on environmental grounds, more cost may have to be

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allowed for environmental mitigation measures. Form of Procurement / Contract: As explained earlier the form of procurement and contract used by the project sponsor can alter the estimated cost of a project. Cost savings may be made by means of lump sum contracts although these are usually marginal in relation to the total project costs. Site Characteristics: A site can be affected by soil and drainage conditions and access restrictions which can affect the original cost estimates. The amount of excavation, piling and foundation activities required are particularly affected by poor ground conditions. Where there is uncertainty about ground conditions, accurate project costing cannot be achieved unless a soul survey in undertaken. This may require the sinking of boreholes to obtain soil samples at different levels beneath the surface. New Build or Improvements: Generally, the construction of new infrastructure is more expensive than improvements to existing

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infrastructure, or the refurbishment of building. This is primarily because the “non –building” costs such as land purchase, foundations, services provision etc. do not have to be included when simply upgrading existing structures. Tax Liabilities: An organization will be liable to pay tax on its purchases. Some organizations and types of project are not liable to pay taxes, or else these can be reclaimed. Local government projects and infrastructure for public use are examples. Some public or quasi –public sector companies, voluntary and private sector organizations can be liable and these tax costs can have a significant impact on gross construction costs. Timescale: Generally, the longer a project takes, the greater the project costs will be. Project timescales are dependent on the specification of a project. Usually, the larger a project is the longer it will take to implement. This is not always the case; if substantial additional resources are used, project may take a lot longer than expected because it’s phasing is dependent upon other,

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linking projects or public finance programmes. A project which involves non –continuous phases is usually more expensive than one undertaken without interruption because of the additional costs involved in re-mobilizing plant and contractors.

Q3. What are the various advantages of ratio analysis? Ans: Ratio analysis is one the techniques of financial analysis to evaluate financial condition and performance of a business concern. In finance, ratio analysis is carried out to judge the liquidity of the organization. It helps the analysts to find if a company is

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capable enough to pay its liabilities. Moreover it also helps to show the operating efficiency and internal return of an organization. Keep in mind that the ratio is good or bad only if it is compared to the industry in which the organization is operating in. According to Myers “ Ratio analysis of financial statements is a study of relationship among various financial factors in a business as disclosed by a single set of statements and a study of trend of these factors as shown in a series of statements.” Advantages and Uses of Ratio Analysis: There are various groups of people who are interested in analysis of financial position of a company. They use the ratio analysis to work out of particular financial characteristic of the company in which they are interested. Ratio analysis helps the various groups in the following manner:1.

To workout the profitability: Accounting ratio help to measure the profitability of the calculating the various profitability ratios. It helps the management to know about the earning capacity

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of the business concern. In this way profitability ratios show the actual performance of the business.
2.

To workout the solvency: With the help of solvency ratios, solvency of the company can be measured. These ratios show the relationship between the liabilities and assents. In case external liabilities are more that of the assets of the company, it shows the unsound position of the business. In this case the business has to make it possible to repay its loans.

3.

Helpful in analysis of financial statement: Ratio analysis help the outsiders just like creditors, shareholders, debenture holders, bankers to know about the profitability and ability of the company to pay them interest and dividend etc.

4.

Helpful in comparative analysis of the performance: With the help of ratio analysis a company may have comparative study of its performance to the previous years. In this way company comes to know about its weak point and be able to improve them.

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To simplify the accounting information: Accounting ratio are very useful as they briefly summarize the result of detailed and complicated computations.

6.

To workout the operating efficiency: Ratio analysis helps to work out the operating efficiency of the company with the help of various turnover ratios. All turnover ratios are worked out to evaluate the performance of the business in utilizing the resources.

7.

To workout short-term financial position: Ratio analysis helps to work out the short – term financial position of the company with the help of liquidity ratios. In case short-term financial position is not healthy efforts are made to improve it.

Accounting ratios indicate the trend of the business. The trend is useful for estimating future.

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