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Overview of project management

Introduction
SAIL wants to modernise all its existing plants, and TATA wants to divest its old businesses to enter into new
economy ventures. Such situations require a sound capital expenditure (budgeting) decision. The basic
feature of capital expenditure is that it involves a current outlay of funds in the expectation of a stream of
future benefits. This section provides a broad overview of capital budgeting.

Phases of capital budgeting


Capital budgeting is a complex process and there are five broad phases. These are planning, analysis,
selection, implementation and overview.
Planning
The planning phase involves investment strategy and the generation and preliminary screening of project
proposals. The investment strategy provides the framework that shapes, guides and circumscribes the
identification of individual project opportunities.

Capital Budgeting Process

Analysis
If the preliminary screening suggests that the project is worth investing, a detailed analysis of the marketing,
technical, financial, economic, and ecological aspects is conducted.

Selection
The selection process addresses the question—is the project worth investing? A wide range of appraisal
criteria has been suggested to judge the worth of a project. There are two broad categories. Non-Discounting
criteria and Discounting criteria. Some selection rules for both methods are listed below: -

Non-discounting criteria Accept Reject


Pay Back Period (PBP) PBP < target period PBP >target period
Accounting Rate of Return
ARR > target rate ARR < target rate
(ARR)

Discounting criteria Accept Reject


Net Present Value (NPV) NPV > 0 NPV < 0
Internal Rate of Return IRR > cost of capital IRR < cost of capital
(IRR)
Benefit- Cost Ratio (BCR) BCR >1 BCR < 1
Implementation
The implementation phase for an industrial project, which involves the setting up of manufacturing facilities,
consists of several stages:
I. Project and engineering designs
II. Negotiations and contracting
III. Construction
IV. Training
V. Plant commissioning

Review
Once the project is commissioned, a review phase has to be set in motion. Performance review should be
done periodically to compare the actual performance with the projected performance. In this stage, feedback
is useful in several ways:

• It focuses on realistic assumptions


• It provides experience, which will be valuable in future decision making
• It suggests corrective action
• It helps to uncover judgmental biases
• It advocates the need for caution among project sponsors.

Levels of decision making


In addition to various phases of capital budgeting, it is important to look at different levels of decision-making.
These are operating, administrative and strategic decision making levels.

Decision Applications (for example) Decided by


Operating Routine maintenance and
Lower-level mgmt.
decisions minor office equipment
Administrative Yearly maintenance and
Middle-level mgmt
decisions Balancing equipment
Strategic
Expansions, diversifications Top-level mgmt/Board
decisions
Portfolio planning tools
Several tools are available to guide strategic planning, decisions, and resource allocation. These tools are
called portfolio-planning tools.
The two most relevant and popular tools are:
Ø BCG product portfolio matrix.
Ø General Electric’s stoplight matrix.
Social cost benefit analysis
Social Cost Benefit Analysis (SCBA) is referred to as economic analysis. In this method, an investment
project is evaluated from the point of view of society (economy) as a whole. SCBA is gaining importance, due
to government investment and support. The various approaches and concepts in this methodology are:
ü Little- Mirrlees approach
ü Unido approach
ü Shadow prices
ü SCBA practice by financial institutions
ü Public investment decision in India

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Project appraisals
Market & demand analysis
The first step in project appraisal is to estimate the potential size of the market for the product
proposed to be manufactured, and get an idea about the market that is likely to be captured. Market
and demand analysis is concerned with two issues:
• What is the likely aggregate demand for the product / service?
• What share of the market will the proposed project enjoy?
The analysis should be conducted systematically. Two broad categories in market and demand
analysis include: collection of secondary information and conducting market survey i.e. collection
of primary information.
Technical analysis
• Selection of technology
• Acquisition of technology
• Purchase of materials and equipments
• Selection of sites and layout of facilities on the site
• Discussion on pollution and effluent disposal
Financial analysis
Once the commercial (technical, market & demand) analysis is completed, the project has to be
assessed in terms of financial feasibility. It will be measured in terms of costs and benefits of the
project. Of the many steps involved, we will discuss the most important topics like cost of project,
working capital requirements. These areas are to be considered before finalising any project.

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Project Planning
Project planning is directly proportional to one’s determination to achieve a specific task. It relates
two aspects of a project:
(1) What one wants
(2) How best one can achieve it
A project involves activities, resources, constraints and inter-relationships that a human being can
analyse and plan informally. Once a project goes beyond a certain level of size, formal planning has
to replace informal planning. Lack of effective planning may lead to chaos. Planning puts forward a
course of action to achieve a predetermined task in a forecasted environment. To install a good
project plan in an organisation, the objectives, the process and other related matters should be stated
clearly.
Objectives of Project planning
The primary objectives of project planning would be to:
(1) Avoid working in a haphazard manner.
(2) Plan for the best execution of projects and apprehend problems
(3) Keep up with the deadlines & budgets specified.
(4) Help in proper communication and coordination
Once the objectives are well defined, they serve as the framework for decisions to be made by the
project manager. A clear set of objectives will enable the project manager to take expeditious
actions, by following a specific process.
Process
All departments, involved in a project, should take part in the planning process of the project.
Participation in the planning process will increase commitment to the objectives and goals. A
planning process can be divided into five phases:
(1) Defining objectives
(2) Delineating tasks
(3) Identifying departments which are involved
(4) Identifying resources
(5) Installing the MIS
The plan prepared should be systematic and flexible enough to include other activities later.
Basically, project plans can be of two types: strategic plans and general plans. A strategic plan scans
the environment from different angles; identifying emerging markets and preparing an action plan
accordingly. Once the strategic plan ends, the general plan is prepared to achieve strategic
objectives.
Project Life cycle
To facilitate the study of various activities of a project, the project life is divided into phases. . In
planning these stages, one has to focus on two points: the rolling wave concept i.e. detailed
planning done for the project development & preliminary engineering; and the integration concept
i.e. planning for all the stages must be integrated. To maintain a consistency in planning, the general
phases/ stages in the project life cycle are:
(1) Project development & Project Engineering.
(2) Bidding and contract negotiation.
(3) Purchase and procurement.
(4) Construction
(5) Commissioning
According to David Cleland the phases of project life cycle are:
(1) The conceptual phase
(2) The validation phase
(3) The full scale development phase
(4) The production phase
(5) The development phase
Phases should enable preparation of a good plan and promote periodic review.
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Project selection
Components of cash flow streams
Analysing a project from the financial perspective, using market and technical analysis. The three
dimensions of financial analysis are:
1. Costs of projects
2. Means of finance
3. Projected income and cash flows
Project from different perspectives
The next step after identifying cash flows is to consider them, in the light of:
• The long-term perspective
• The equity perspective
• The total fund perspective
There are certain principles to be followed in estimating the income from project which will be
applicable for all the three different perspective to cash flows. These are:
• All costs and benefits are to be measured only in terms of cash flows.
• Net cash flows for the firm are those, which accrue after paying tax.
• Cash flows must be measured in incremental terms.
Various appraisal criteria
After analysing the costs and benefits of a project in terms of cash flows, the focus now shifts to the
assessment of the project’s worth. But before we do so, certain assumptions are made:
• The risk of project proposals should be in line with existing investment projects of the firm.
• The firm has certain benchmarks to evaluate projects.
Appraisal methods can be classified into two broad categories:
• Discounted cash-flow criterion
• Non-discounted cash flow criterion

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Net Present Value


The Net Present Value (NPV) is a discounted cash flow approach, to appraise and selection of a project. It is
also useful in capital budgeting decisions. The NPV of an investment proposal is the present value of net
cash inflows, less the initial cash outflow of the project. It is also represented as:
…………………..
NPV = CF0 + CF1 + CF2 + + CFn
0 1 2 n
(1+k) (1+k) (1+k) (1+k)
n
= å CFt
t
t=0 (1+k)
Where, NPV= net present value
CFt = cash flow occurring at the end of year t (t = 0, 1,….. n).
Cash inflow will have positive or no sign and cash outflow will
have negative sign.
n = life of the project
k = cost of capital
To illustrate the calculation of NPV, consider the following project cash flow stream:

YEAR CASH FLOWS (in Rs)

0 -15,00,000

1 1,00,000

2 3,00,000

3 5,00,000

4 6,00,000

5 7,00,000

Now, if the cost of capital (k) is 10%, then the net present value of the project is:
NPV = (-)15,00,000 + 1,00,000 + 3,00,000 + 5,00,000 + 6,00,000 + 7,00,000
0 1 2 3 4 5
(1.10) (1.10) (1.10) (1.10) (1.10) (1.10)
= Rs.58,953.40

RATIONALE OF THE NPV METHOD


If the NPV of any project is zero then it means that the return from the project is equal to the outflow of the
project. There is no chance of making a profit from the project. A positive NPV indicates that project earns
more than its cash outflow and is profitable. In the case of negative NPV, the implication is vice-versa.

Accept-reject rule
ü The proposal for investment will be accepted if the NPV is positive, and rejected if the NPV is
negative.
ü If the NPV is zero then the project is in an indifferent position.
ü If a choice has to be made between two projects, the project with higher NPV will be accepted for
investment.
Like other appraisal criteria, NPV also has some benefits and drawbacks. The pros and cons are as follows:

Pros

 The most significant benefit of NPV is that it considers the time value of money in calculations.
 It considers the total benefit of an investment proposal over its lifetime.
 Changes in the discount rate are easily reflected in the evaluation process.
 NPV allows easy comparisons of returns from different projects, which enables rational resource
allocation decisions to be made
Cons
Ø NPV cannot differentiate between a project with higher cash flows and a project with lesser cash
flows in the early years
Ø It does not provide the same base for comparison between two projects, with different lives of
cash outflow
Ø It is an absolute measure, and does not consider initial cash outlays. Hence, it may not provide
dependable results.

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Accounting Rate of Return


The accounting rate of return is a measure of profitability, which links income and investment. There are
different ways to compute the accounting rate of return, since income and investment are measured in
various ways. The common practices of measuring the accounting rate of return are: -
1. Average income after tax
Initial investment
2. Average income after tax
Average investment
3. Average income after tax, but before interest
Initial investment
4. Average income after tax, but before interest
Average investment
5. Average income before interest and taxes
Initial investment
6. Average income before interest and taxes
Average investment
7. Total income after tax, but before depreciation – Initial investments
Initial investment * Years
2
Calculation for measuring accounting rate of return is as follows: -

Year Invest- Depre- Income Interest Income Tax Income


ments ciation before before tax (Rs.in after tax
interest (Rs.in (Rs. in crores)
(Book (Rs.in and tax crores) crores) (Rs.in
value) crores) crores)
(Rs.in (Rs.in
crores) crores)

1 200 40 100 20 80 25 55

2 160 40 95 20 75 20 55

3 120 40 80 20 60 20 40

4 80 40 80 20 60 15 45

5 40 40 85 20 65 20 55
Sum 600 200 440 100 340 100 250

Avg. 120 40 88 20 68 20 50

Calculation of ARR by using various methods


1. Average income after tax = 50 = .25 * 100 = 25 %.
Initial Investment 200
2. Average income after tax = 50 = .42 * 100 = 42 %.
Average Investment 120
3. Average income after tax, but before interest = 50+20 = 70 = .35 * 100 = 35%.
Initial investments 200 200
4. Average income after tax, but before interest = 50+20 = 70 = .58 *100=58 %.
Average investments 120 120
5. Average income before interest and taxes = 88 = .44 * 100 = 44 %.
Initial investments 200
6. Average income before interest and taxes = 88 = .73 * 100 = 73 %.
Average investments 120
7. Total income after tax, but before depreciation – Initial investments
Initial investment * Years
2
= (250 + 200) - 200 = 250 = .50 * 100 = 50 %.
200 * 5 500
2

Accept—Reject Rule
According to the Accept—Reject Rule for ARR, we have to compare the actual or calculated ARR with the
pre-determined minimum ARR or the minimum required return, to accept any project. A project with a higher
ARR than the minimum ARR qualifies for acceptance.
We can also use a rating method when more than one project is available for selection with every project
having ARR more than the minimum ARR. In such a scenario, we can arrange the projects in descending
order of ARR and then make a final decision.
Like all other project appraisal models, ARR also has its pros and cons.

Pros
• Accounting information is always readily available and easy to calculate
• Benefits accruing during the entire life of the project

Con
• Accounting profits are focused on only accounting cash flows ignoring actual cash flows in a specific
period
• The time value of money is not considered.
• Investment size and risk involved in the projects, are overlooked

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Multiple Projects and Constraints
In the existing environment, an organisation cannot consider a capital investment project
individually as certain pre-conditions require to be fulfilled.
Constraints: Project dependence, capital rationing and project indivisibility are factors that restrict
isolated project selection. If the acceptance and rejection of one influences the cash flow stream of
the other or affects the acceptance and rejection of others, then the two projects are said to be
economically dependent. The three types of economic dependency are as follows:
1. Mutual exclusiveness
2. Negative dependency
3. Positive dependency (complementariness).
Capital rationing occurs when funds available are not adequate to undertake all the projects that are
acceptable otherwise. It also arises because of internal limitation or an external constraint.
A project cannot be accepted or rejected partially, it is indivisible, and has to be accepted or rejected
in totality.
Methods for comparison: Factors like economic dependency, capital rationing or project
indivisibility emphasise the need for comparison of projects. The methods used for comparing
projects are:
1. Method of ranking: Joel Dean originally proposes a method of ranking. It consists of two steps:
(i) Ranking all the projects in decreasing order of the NPV’s, IRR’s, or BCR’s. Assumptions in
these 4 methods are:
NPV method: The intermediate cash flow is re-invested at a rate of return equal to the cost of capital
of the firm.
IRR method: Cash flow is re-invested at a rate of return equal to or greater than the Fisherian rate of
return.
BCR criterion: The intermediate funds are reinvested at a rate of return greater than the Fisherian
rate of return.
Accepting all projects in that order until the capital budget is exhausted.
(ii) All combination of feasible projects should be defined, given the capital rationing constraint and
project dependencies. Then choosing a combination having the highest NPV is known as the
feasible combination procedure.
Problems: There are two major problems related to this method (i) because of the discounted cash
flow criteria, conflict arises in the ranking. (ii) Indivisibility of the project.
2. Mathematical programming approach: Two broad categories of equations are considered for
formulations in the mathematical programming approach:
(a) The objective function and (b) The constraint equations
The following three models are commonly used:
(i) Linear programming model: Assumes that the objective function and the constraint equation are
linear while the decision variables are continuous.
(ii) Integer linear programming model: It is presupposed that decision variables assume a value of 0
or 1.
Advantages of the method: (a) It overcomes the problem of partial projects which besets the linear
programming model and. (b) It is capable of handling virtually any kind of project interdependency
like mutual exclusiveness, contingency and complementary.
(iii) Goal programming model: It solves the programming problem of minimising the
absolute deviation from specific goals in order of the established priority structure.
(iv)

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Technical Analysis
Technical analysis is mainly concerned with:
1. Material inputs and utilities
2. Manufacturing processes
3. Product mixes
4. Plant capacities
5. Locations and sites
6. Machinery and equipments
7. Structures and civil work
8. Project charts
9. Lay outs & work schedules
When a project is undertaken, the analysis of technical and engineering aspects becomes a
continuous process. Technical analysis defines the materials and inputs required, their properties
and the supply programme. It classifies material inputs into four categories: (a) raw materials (b)
processed industrial materials (c) auxiliaries materials and factory supplies (d) utilities.
Evaluation of Technological Options
The evaluation of technological options provided by suppliers should be based on the following
considerations. The technology should be:
1. Proven and tested; preference could be given to the technology used by the market leader.
2. Up- to –date; otherwise, the risk of obsolescence is high.
3. Cost effective and par excellence.
Choice of technology
The choice of technology is influenced by many factors such as:
• Plant capacity
• Principal Inputs
• Investment outlay and production cost
• Use by other units
• Product Mix
• Latest Developments
• Ease of integration
Elements of technology transfer
The process of technology transfer consists of three elements:
(1) Transfer of Documentation: All the information essential for the execution of all phases of the
project should be passed to concerned functions during the technology transfer.
(2) Assistance in Implementation: During implementation, skills required for the modification of
technology should be provided for the transition to be smooth.
Upgrading of Technology: As technology is updated on a timely basis, it is necessary for the buyer
to check that the seller is providing the latest version of the technology.
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Social Cost Benefit analysis


The main focus of SCBA is analysing the social costs and benefits of a project, which often vary
from the monetary costs and benefits of the project. There are six main principle sources of
discrepancy when assessment of a project is done purely from a commercial point of view:
(1) Market Imperfections: According to the project sponsor, market price is the basis for the
computation of monetary cost and benefits. Market price does not reflect social values when there is
a discrepancy in the market. It reflects social values under perfect market conditions, which is very
rare in a developing market.
Some of the market imperfections commonly found in developing nations are as follows:
• Rationing: The price paid by the consumer is less than the price prevailing in the
competitive market.
• Prescription of minimum wage rates: The wages paid to labour exceed the wages offered in
a competitive labour market.
• Foreign exchange regulations: In most developing countries, the official rate of foreign
exchange is less than the rate that prevails in the absence of foreign regulation, a reason why
foreign exchange commands a premium in unofficial transactions.
(2) Externalities: Projects have external effects, which are known as ‘externalities’. Example,
Creation of infrastructural facilities like roads, which may benefit neighbouring areas, are
considered by SCBA, though monetary benefits are ignored while assessing the benefits of the
project sponsors.
Another example is that of an industrial project, which produces lot of smoke resulting in
environmental pollution. The social costs of such pollution should be relevant to the project sponsor
although the monetary cost is not relevant.
(3 Taxes and Subsidies: For the project sponsor, taxes are monetary costs, and subsidies are
monetary gains. However, from a social standpoint, taxes and subsidies are generally considered as
transfer payments and are hence irrelevant.
(4) Concern for Savings: A private firm is not concerned how its benefits are divided between
consumptions and savings. It does not put differential valuation on savings and
consumption. From a social point of view, the division between savings and consumptions is
essential, mainly in capital scarce countries. Societal concern for savings and investment is
reflected in SCBA where a higher valuation is placed on savings and a lower valuation on
consumption.

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Socially Responsible Investing


Today there is a widespread concern over environment preservation with issues on toxic waste,
global warming et al drawing the attention of responsible citizens all over the world. These issues
become glaring with incidences of numerous oil spills or chemical disasters like Union Carbide’s
(Bhopal’s) Gas tragedy. These apart, there are social issues such as diversity in the workplace,
employee issues, human rights in factories, and socially destructive products such as tobacco
”Socially Responsible Investing is the act of making investment decisions to achieve social as well
as a financial returns”.
It is a strategy to shun companies that damage the environment (either by ill treating nature or
people), and favour companies that deliver positive returns, be it goods or services.
Socially Responsible Investing (SRI) is the idea and practice of investment based on ethical criteria.
SRI is just like traditional investing. Every investor is in pursuit of common economic goals viz.
capital gains, higher income and/or preservation of capital for future needs. Socially concerned
investors go a step further. They would not like to see their investments causing harm to the social
or physical environments. They would certainly want their investments to be directed towards
necessary and life-supportive goods and services. This can be done in two ways:
• Avoid harmful investments: – This means, refraining from investing in companies that
produce or distribute tobacco, liquor, nuclear power, weapons, etc.
• Make socially beneficial investments: This could include companies that provide social
benefits such as hospitals, health care suppliers, educational companies, etc.
There are three primary strategies that any investor should follow for SRI, namely, Screening,
shareholders activism and Community investing. Screening involves choosing specific companies
securities on basis of their positive contribution towards society or the environment and exclude
companies producing negative returns. Here are some examples of industries social investors
generally avoid: -
• Alcoholic beverages
• Animal use for testing
• Gambling
• Business associations with
• Military products
an unethical country
• Pornography or explicit ads
• Industries with high
• Produces product that can pollution
kill

The industries where SRI is generally directed include: -


• Renewable energy
• Life saving products • Companies promoting
recycling
• Educational material
• Companies with good track
• Health Care equipment
records of recruiting
minorities

The second stage of SRI is shareholder activism where they exercise their rights as corporate
owners to advocate their issues of concern like deforestation or employee wages. They can express
themselves through dialogues with management, shareholders resolutions, or divestment.
Community investing is the third option, which includes providing low interest rate loans to
people in low-income communities. It includes organising community development banks and non-
profit cooperative societies, which finance housing, small business loans and other local projects.
Community investing provides an effective way for socially oriented investors to put money into
grass root development projects and provide direct route to gain social returns. The emerging
benefits at the community level in many cases outweigh diminished financial returns, making
community investing one of the most satisfying and promising venues for SRI in future.

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Detailed Project Report


The total business plan requires a wide range of information, to ensure that funds are granted for a
project. Detailed Project Report (DPR) is a part of the total business plan submitted to venture
capitalists or financial institutions. It is the culmination of all analyses related to the project. The
analyses- market and demand as well as technical and financial are presented in a systematic
format, in the DPR. The other related information like the background of promoters, location of the
company is also attached with the main report.
There is no set pattern for the DPR. The broad guidelines, however, are:
Contents of DPR
General information
The information provided in this section, could be as follows:
• Name of the industrial concern
• Constitution of the proposed company (for e.g. whether it is public or private limited)
and sector
• Nature of industry and product
• Name of the promoters and their contribution to the proposed project
• Cost of the project
• Means of finance
Promoters’ details
The business and family background of the promoter(s) are mainly discussed under this heading.
Their previous business experience and performance, if any, will be explained here. The auditor(s)
report of the previous business and the reason for closure will also be clarified. Whether, the
proposed venture is related with existing business and will help them do better, will also be noted
here.
Marketing and Selling Arrangements
The network of marketing and selling arrangements for the disposal of the product will be
explained.
• Brief notes on the product, major uses, scope of the market, possible competition from
substitutes
• Detailed notes on the existing and future demand
• Information on the export possibilities and the nature of the competition from foreign
competitors
• Information about distribution, selling agent, and selling organisation
• Remuneration of selling agents, and relationship of the directors with the selling agent(s)
• Details regarding the trend in prices during the last five years
Particulars of the project
• Product mix and capacity
• Location and site
• Plant and machinery
• Raw materials
• Utilities
Technical Arrangements
The technical infrastructure required to start the project, and whether the promoters have any
foreign collaboration(s) for the project will be explained here. The cost of buying or installing
technical infrastructure and whether it is cost effective, will be clarified under this heading.
Production Process
Explain in detail, the technical process proposed to be employed. Enclose copy of the process
flow chart with material balance, utilities and process parameters.
Compute application results of the proposed process
Environmental Aspects
The impact of discharging effluents of the production process in the environment, as well as,
precautions that have to be taken will be dealt with, in this area of the report
• Furnish details of the nature of atmospheric, soil and water pollution. Indicate whether
necessary permissions for the disposal of effluents have been obtained
• Enclose copy of approval from concerned authorities
Schedule of Implementation
• Describe how design engineering, erection, installation and commissioning of the project
will be carried out
• Furnish the schedule of implementation
Cost of the Project
The detailed break up of all costs related with the project, has to be listed, here:
• Land
• Site development
• Buildings and other civil works
• Plant and machinery
• Technical know how fees
• Expenses on technicians
• Miscellaneous Fixed Assets (MFA)
• Preliminary
• Preoperative expenses
• Provision for contingencies
• Margin money for working capital (give details of calculations)
Means of Finance
The break up and sources of funds for the project are discussed:
• Equity- Promoters, Financial Institutions, Public holdings, and others
• Pref. Shares
• Subsidy (if any)
• Term loans
• Debentures
• Unsecured loans and deposits
• Deferred payments
• Internal accruals
• Bank borrowings
• Working capital
• Others
Profitability estimates
• Assumptions
• Projected income statement
• Projected balance sheet
• Projected cash flow statement
Appraisal based on profitability estimates
• Give estimates of costs of production and working results for the first 10 years in annexure
• Provide a cash flow statement for the company as a whole
• Provide a projected balance sheet for ten operating years
• Give the break even and sensitivity analysis for the project
Economic considerations
• Give prices of competing import and export products, with break ups--FOB, CIF, and landed
costs and selling prices.
• Provide explanation for differences in prices, between the product and those imported
• Give the international CIF/FOB prices of all inputs
• Brief write ups on the economic benefits to the region and country due to the proposed
project
Appendices
• Estimates of costs of production
• Calculation of depreciation
• Calculation of working capital and margin money for working capital
• Repayment/ Interest schedule of term loan and finance
• Calculation of tax
• Various Coverage ratios
• Various Evaluation technique like NPV, IRR, NBCR, BCR, PI, DPB etc. to evaluate the
project and its viability
• Sensitivity analysis

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