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COURSE : MBA - 3 rd SEMESTER
SANTHOSH AIYAPPAN INTRODUCTION TO PROJECT MANAGEMENT
Roll Number: Assignment Number:
PM0001 – SET 2
Date of Submission:
August 10, 2010
1.What are the various methods of demand forecasting? Explain in detail
Methods No demand forecasting method is 100% accurate. failing to forecast demand ignores two important phenomena. Demand forecasting involves techniques including both informal methods. such as educated guesses. Methods that rely on qualitative assessment Forecasting demand based on expert opinion. But.with some practical tools: Demand forecasting is the activity of estimating the quantity of a product or service that consumers will purchase. such as the use of historical sales data or current data from test markets. and quantitative methods. or in making decisions on whether to enter a new market. Demand forecasting may be used in making pricing decisions. Necessity for forecasting demand Often forecasting demand is confused with forecasting sales. The main question is whether we should use the history of outbound shipments or customer orders or a combination of the two as proxy for the demand. Some of the types in this method are. since the historical demand forms the basis of forecasting. • • Unaided judgment Prediction market . Combined forecasts improve accuracy and reduce the likelihood of large errors. in assessing future capacity requirements. There is a lot of debate in demand-planning literature about how to measure and represent historical demand.
First applications of the Delphi method were in the field of science and technology forecasting. a facilitator provides an anonymous summary of the experts’ forecasts from the previous round as well as the reasons they provided for their judgments. in a single indicator.• • • • • • Delphi technique Game theory Judgmental bootstrapping Simulated interaction Intentions and expectations surveys Conjoint analysis Methods that rely on quantitative data • • • • • • • • Discrete Event Simulation Extrapolation Quantitative analogies Rule-based forecasting Neural networks Data mining Causal models Segmentation Delphi method: The Delphi method is a systematic. of the particular technology. The experts answer questionnaires in two or more rounds. interactive forecasting method which relies on a panel of experts. assessed the direction of long-term trends in science and technology development. The objective of the method was to combine expert opinions on likelihood and expected development time. After each round. . One of the first such reports. prepared in 1964 by Gordon and Helmer.
Game theory: Game theory is a branch of applied mathematics that is used in the social sciences. or virtual markets) are speculative markets created for the purpose of making predictions. event derivatives. will the next US president be a Republican) or parameter (e. population control. health and education.g.covering such topics as scientific breakthroughs. Prediction markets are thus structured as betting exchanges.. war prevention and weapon systems. automation. Other forecasts of technology were dealing with vehicle-highway systems. engineering. The current market prices can then be interpreted as predictions of the probability of the event or the expected value of the parameter. and technology in education. especially those related to public policy issues. Later the Delphi method was applied in other areas. Assets are created whose final cash value is tied to a particular event (e. without any risk for the bookmaker. Prediction markets Prediction markets (also known as predictive markets. information markets. political science. as well as in biology (most notably evolutionary biology and ecology). such as economic trends. international relations. decision markets. Game theory attempts to . industrial robots. idea futures. Evidence so far suggests that prediction markets are at least as accurate as other institutions predicting the same events with a similar pool of participants. total sales next quarter). while those who buy high and sell low are punished for degrading the market prediction. broadband connections. space progress. People who buy low and sell high are rewarded for improving the market prediction. and philosophy. computer science. most notably in economics.g. It was also applied successfully and with high accuracy in business forecasting. intelligent internet..
assuming similar methods will be applicable. which constructs new points between known points. the selection of projects to be implemented will be based on the stream of cash flows (both inflows and outflows). The method to be used will depend on the selection criteria to be decided by the management.mathematically capture behavior in strategic situations. or expand known experience into an area not known or previously experienced so as to arrive at a (usually conjectural) knowledge of the unknown (e. "game theory is a sort of umbrella or 'unified field' theory for the rational side of social science. 2. it has been expanded to treat a wide class of interactions. While initially developed to analyze competitions in which one individual does better at another's expense (zero sum games). Today. extrapolation is the process of constructing new data points outside a discrete set of known data points. plants)" Extrapolation: In mathematics. but the results of extrapolations are often less meaningful. extend. where 'social' is interpreted broadly. to include human as well as nonhuman players (computers. It is important to keep in mind the points that need to be considered while . It is similar to the process of interpolation.What are the methods of financial appraisal? From the financial viability viewpoint. animals. which are classified according to several criteria. Extrapolation may also apply to human experience to project. and are subject to greater uncertainty.g. It may also mean extension of a method. a driver extrapolates road conditions beyond his sight while driving). in which an individual's success in making choices depends on the choices of others. for which estimates are worked out as noted in the preceding section.
. • Non –discounting criteria.estimating the costs incurred and the income realized from the project in the consecutive years of the project’ operation. A brief description of cost of capital is given in the succeeding section. net cash flow must be computed in post. All costs and incomes (benefits) need to be measured in terms of cash flows. The discounting rate to be used for this computation is popularly accepted as the ‘cost of capital’ in percentage (k). The net cash flow accrues to the firm only after paying tax. Cost of capital can be defined as the minimum discount rate that must be earned on a project keeping the market value of the firm constant. we can broadly divide the financial viability criteria in two categories as under: • Discounting criteria – These criteria consider the time value of money. With the above –mentioned points I the background. These points are as under: 1. only the incremental cash flows arising out of the additional project should be considered. For an additional project being considered by an company which is already in operation.These criteria do not consider the time value of money i. This means that that all non –cash charges or expenses like depreciation should be added back to the PAT to arrive at net cash flows. 3. Another understanding of the cost of capital is that it is the expected rate of return offered to the investors by the equivalent risk investments traded in the capital markets.tax terms. Hence. 2.e. the future year’s cash flows are considered on the same footing as the investment / cash flows in the initial year / years.
t varying from 0 to N i.e. in which case CF1. Discounting criteria: The different discounting techniques are: Net Present Value (NVP) NVP is the present algebraic value of all future cash flow discounted at ‘k’. the investments may continue to be made in year 1. CF2 etc. Initial investment t will be subtracted from RHS of the equation where CFt = Cash flow in year t. year 2 etc. the no. The formula for NPV is Note: If summation is made from t= 1 to t = N. Will be entered accordingly in the equation k= Cost of capital (computation of k is discussed in subsequent section.A. Cash inflow taken as (+) and Cash outflow taken as (-) CF0 will be the investment made in year 0 and will be (-). of years of project life. .
the NPVn will be higher than NPV and vice versa. then the TV has to be reduced to its present value and the NPV will be equal to the present value of TV minus the present investment (assuming the entire investment is made in year 0). the one with the higher NPV is selected. can increases as the cost of capital decreases. cost of capital.k reflects the risk of the project. In case the reinvestment rate is ‘r’. The project is Accepted if NPV is (+) Rejected if NPV is (-) Point of indifference if NPV = 0 If there are 2 or more mutually exclusive projects. then the Terminal Value (TV) of the cash inflows of the project has to be computed. Modified NPV (NPVn) The assumption in the NPV method above is that the cash flows are reinvested at a rate of return equal to k i. . The formula for modified NPV (denoted as NPVn) is I = investment outlay It can be noted that if the reinvestment rate is higher than the cost of capital. It can be noted that the NPV decreases as the cost of capital increases.e.
Internal Rate of Return (IRR) The IRR is the discount rate (k) at which NPV=0 By way of a formula. Modified IRR (IRRn) . marginal efficiency of capital. k is taken as the cost of capital which is determined based on the factors external to the project proposal. The company sets a cut –off rate for comparing with the IRR computed. Although the IRR can be considered as the case for NPV=0. we must understand the differences between the implication of NPV and IRR. In the NPV method. The project is accepted if IRR is greater than the cut –off rate. the IRR is the value of ‘k’ derived from the equation hereunder: The IRR is also known as ‘yield on investment’. the project with the highest IRR is selected. In the IRR method. marginal productivity of capital etc. the discount rate is the rate of return based on the factors that are internal to the project proposal. For more than one project being evaluate.
The formula for BCR is thus: .e. The NPV method computes the differences between the present value (PV) of the future cash benefits and the initial investment. Benefit –cost ratio (BCR.e. also known as Profitability index PI) This is the ratio of the present value of future cash benefits to the initial investment.e. And PVC is the present value of the costs associated with the project i.The IRR method shown above is based on the assumption that the cash inflows of the project are reinvested at the same IRR rate. If the reinvestment rate (r) is different. TV is the terminal value of cash inflows expected from the project i. The present value of future cash benefits is computed using the same Time-value of money technique used in the NPV method. IRRn is to be computed after calculating TV as explained in the NPVn method above. then the modified IRR i. The formula for IRRn is Here. whereas the BCR method calculated the ratio of future cash benefits to the initial cash flow.
The project is Accepted if NBCR is +ve Rejected if NBCR is – ve Point of indifference if NBCR = 0 In case of more than one project. the present value of future cash flows are calculated and added. It is advantageous when capital rationing is used. the project with the highest +ve NBCR is selected.The project is Accepted if BCR > 1 Rejected if BCR < 1 Point of indifference if BCR = 1 If there are two or more projects being evaluated. the one with the highest BCR will be selected. Net benefit cost ratio (NBCR) The formula for NBCR id NBCR = BCR – 1 It measures the ratio of the net benefit of the project rather than the gross benefit. Discounted Payback Period In this method. The number of years for which this total becomes equal to the initial .
The different non –discounting techniques are Payback Period Here.investment I is considered as the payback period. If the annual cash inflows are equal. Then The criteria foe project selection is the same as the mentioned under Discounted payback period. Average Rate of Return (ARR. Non .discounting Criteria. also called Accounting Rate of Return) The formula is . the future annual cash flows are algebraically added without considering the time–value of money. B. the project is Accepted. This can include a fraction of the year. If the discounted payback period is less than the standard. the project is Rejected. This payback period is compared to the payback period set as the standard for accepting the project. If it is more than the standard.
3.” Closely related. but differs in that it is explicitly designed to inform the practical decision-making of enterprise managers and investors focused on optimising their social and environmental impacts. formal techniques include cost-effectiveness analysis. whether explicitly or implicitly. The formal process is often referred to as either CBA (Cost-Benefit Analysis) or BCA (BenefitCost Analysis). weighing the total expected costs against the total expected benefits of one or more actions in order to choose the best or most profitable option.What do you mean by social cost benefit analysis? Explain with a example. which itself is a process known as project appraisal. the case for a project or proposal. and an informal approach to making economic decisions of any kind. fiscal impact analysis and Social Return on Investment (SROI) analysis. • Under both definitions the process involves. Benefits and costs are often expressed in money terms. economic impact analysis. but slightly different. so that all flows of benefits and flows of project costs over time (which tend to occur at different points in time) are expressed on a common basis in terms of their “present value. or assess. and are adjusted for the time value of money. Cost-benefit analysis is a term that refers both to: • helping to appraise.A project with a higher rate of ARR is preferred. The latter builds upon the logic of cost-benefit analysis. An example of social cost benefit analysis of Delhi metro are summarised as example: .
The incremental changes in the incomes of various economic agents: passengers. transporters. public. The social rate of return on investment in the Metro is as high as 22.6 million. respectively. 30 and 10 percent.30 and 1. number of accidents on roads and the atmospheric pollution. The estimated NPSB of the Metro at 2004-05 prices and the 8 percent social time preference rate for the Indian economy is Rs. passengers and unskilled labour while there are substantial income losses to the transporters because of the Metro.The Delhi Metro planned in four phases is part of an Integrated Multi Mode Mass Rapid Transport System (MRTS) planned for dealing with the fast growing passenger traffic demand in Delhi. The social cost-benefit analysis of the Metro requires the identification of benefits and the economic agents affected by it. It reduces the travel time of people using the road and Metro. 419979. It provides an alternative safe and comfortable mode of transport by rail to a large fraction of passengers using the road transport in Delhi. It is found that there are income gains to the government. Social cost-benefits of Delhi Metro Savings in travel time Due to reduction in travel time for Metro passengers .92 at 8 percent and 10 percent discount rates respectively while its financial internal rate of return is estimated as 17 percent. The shares of debt.7 percent. equity and internal resource mobilization in investments made on Metro are 60. The financial evaluation of the Metro is done considering the financial flows of the project comprising the annual revenue earned and flows of investments and operation and maintenance costs. The financial cost-benefit ratio of the Metro is estimated as 2. public and government and unskilled labour due to the Metro could be estimated by considering the Delhi economy with and without the Metro.
Reduction in accidents Reduction in the number of vehicles on road Savings in fuel consumption Reduction in air pollution Savings in passenger time Savings due to fewer accidents Savings in vehicular operating costs due to the decongestion effect Savings in Capital and Operating Cost of Diverted vehicles .