Project Planning

Project Identification and Project Formulation 4

OBJECTIVES
After going through this chapter, the student will be able to understand
the following:
The concept of a project
The meaning of a project
The characteristics of a project
The classification of
projects
The process of project
planning
Project identification
The detailed process of
project formulation
Market and demand analysis
.The objectives of
market
analysis
.The concept of
demand analysis
The various methods of
demand analysis
The concept of material balance and
input/output method
Field survey

4.1 INTRODUCTION
An entrepreneur takes various decisions to convert
his business 1dea
into
enterprise. An entrepreneurs' decision-making process starts with the selection a successfiul
of a neo:
Project selection is the first cornerstone to be laid down in setting up an
enterprise.
or failure of an
entrepreneur largely depends upon the kind of project selected. The succecc
as an idea, a need or an
opportunity that is to be assessed, analysed and ultimately beein
Project
into a project. The well-known develo
English proverb 'well begun is half done' is applicable
the project selection dh
phase. uring
 4.2 MEANING OF PROECT
aiect is a scheme, design or a proposal intended or devised to achieve a particular aim. A
Projed
ct has
project has a distinct mission that it is designed to achieve and clear termination point after
chievement of the mission. According to Encyclopaedia of management, 'a project is an
the achievo

nized unit dedicated to the attainment of goal, the successful completion of a development
organiz

o n time, within budget, in conformance with predetermined programme specifications. A

task
eniect usually differs in size, nature of objectives, time duration and complexity.
projec

Source: http://economictimes.indiatimes.com/thumb/msid-21098577, width-640.

resizemode-4/breakthrough-solar-wind-power-projects-in-india jpg
Illustration 4.1 Different Types of Projects

4.2.1 Characteristics of a Project

The foliowing are the characteristics
of a project:
I. A project involves investment of money.
2. The goal of a project is to earn profit.
and services.
or manufacturing of goods
3. It deals with the production
the new ones.
are associated
with projects especially
4. Risk and uncertainty
5. It is subjected to lot of changes.
end.
6. It has a definite beginning and an

maturity and decay.

. I t has a life cycle consisting of growth, materials, machinery. people,
elements such as technology, equipment,
various
t requires
etc.
work is requirea.
F o r the successful completion
of a project, team
 4.2.2 Classification of Projects
below:
Projects can be classified into various categories as explained
1. Quantifiable and non-quantifiable projects: Quantifiable
projects are those in which
Various industrial development, power
the quantitative assessment of benefits is possible.
and will therefore fall under
generation, mineral development projects can be quantified
this category. Non-quantifiable projects are those in which the benefits cannot be directly
measured quantitatively. Projects involving health, education, defence, etc., fall under
this category.
2. Sectoral projects: According to the Planning Commission of India, a project may fall in
the following categories:
(a) Agriculture and allied sector

(b) Irigation and power sector

(c) Miscellaneous sector
(d) Transport and communication sector
(e) Industry and mining sector
() Information technology sector
3. Techno-economic projects: Projects may be classified into the following categories:
(a) Factor-intensity-oriented classification: Projects may be classified on the basis of
investment in factors of production.
Project may be termed as labour intensive if
large investment is made in manpower and capital intensive if large investment is
incurred in plant and
machinery.
(b) Causation-oriented classification: Projects may be classified on the
basis of the cause
of its origin. It may be classified as demand-based or raw-material-based projects.
If a project is started by an
entrepreneur due to non-availability of certain goods or
services and consequent demand for such
as demand-oriented
goods or services, the project is termed
project. However, the project is started by an
if
because the raw materials are entrepreneur
readily available or are in abundance, the
termed raw-material-oriented project.
as project is
(c) Magnitude-oriented
of investment in the
classification: Projects may be classified on the basis of the size
project. Under this
scale, medium-scale and small-scale. category. projects may be classified as large
The projects are also classitied according to their
The classification is age, experience and the
as follows: purpose of the project.
. Profit-oriented projects:

(a) New projects

(b) Expansion projects
(c) Modernization projects
(d) Diversification projects
 2. Service-oriented projects
(a) Welfare projects
(b) Service projects
(c) Research and development projects
Projects can be classified according to the urgency of the execution as follows:

.Normalprojects: Normal projects are allowed time for implementation of

adequate
normal/routine projects. Such type of projects will require minimum capital cost.
2. Crash projects: In crash projects, additional capital costs are incurred to save time. it
S Usually done during procurement and construction where extra time is sought from
vendors and contractors by making additional payment to them.

Box4.1-Empire State Building Project, New York, NY

Source: http://static.guim.co.uk/sys-images/Guardian/Pix/pictures/
2010/7/26/1280184132277/Empire-State-Building-and-001jpg
Empire State Building is known as one of those incredible landmarks that had symbolized
hope during a time of despair in American histony. The Empire State Building project
is one of those historical projects that demonstrate that motivation plays a large role in
a project's success. It was designed by William Lamb. It was built during the height of
the Great Depression and it took less than 18 months involving over 3,400 workers at a
cost of approximately $40,948,900. The building was officially opened on May 1, 1931
as the first structure to have more than 100 floors, 6,500 windows, 73 elevators and
1,860steps

4.3 PROJECT MANAGEMENT

Project management is the processofplanning, organizing, monitoring and controlling a project
and motivating all involved in a project to achieve project objectives within the specified
time, cost and performance. Good project planning results in greater profitability and greater
customer satisfaction. Therefore, it is necessary to plant a project well.
4.3.1 Process of Project Planning
of project planning:
The following figure depicts the process

Selection
Formulation Appraisal
ldentification

Process ofProject Planning

Figure 4.1
the current chapter. Project appraisal is
identification and fomulation have been discussed in
Project after project appraisal.
discussed in solution automatically takes place
chapter 5. Project

Project identification
and it involves careful analysis from many
Identifying a new project is a complex problem
which new project ideas may emerge are as follows:
different angles. Some of the sources from
industries: Performance of an existing industry
1. Analysis and performance of existing
health ofa particular industry. An analysis of the
provides a good indicator about the information about the financial
profitability of different industries will provide adequate
should not be taken as the
health of different industrial sectors. Although performance
but the stage of business cycle in which the
only criteria for identifying an opportunity, industrial sector
different industries stand at a particular time is very crucial. particular
A
crossed its saturation stage and
might be performing well, but it might have already
business cycle. Such factors are to
might have already fallen into the decline stage of its
be carefully analysed before making any major decision.
2. Availability of raw materials: Easy availability of good quality raw materials at cheaper

prices gives
an for starting up new projects based on availability of raw materials.
opportunity
3. Availability of skilled labour: Based on the locally available skilled labour force,
suitable industries that can make better use of the skilled manpower can be recognized.
4. Import/export ratios: Import/export ratios and statistics may reveal the potential that
has remained untapped. Higher proportion ofimport ofa particular product indicates an
increasing trend in its import and such a product can be substituted by producing locally.
Similarly, increasing proportion of export of a particular product indicates an increasing
trend in its export and a high potential for the substitute product.
5. Price trend: The recent trend in the price of various products/services may act as an
indicator about the demand-supply relationship. In case, the general price leveBl is rising
during the past few years and if the rise in price level of a particular product is steeper
than the rise in general price level, it may indicate a demand-supply gap. The detailed
study of demand-supply gap may be very useful for choosing a new project.
6. Research and development activities: Rescarch teams that are engaged in identifying
new products or processes sometimes offer new avenues for commercial exploitation.
However, failure to correctly simulate conditions may lead to failure when the product 1s
produced in a large scale.
7. Plan outlay and Government guidance: The Government plays an important role i
the economy of a country. Government's plan of future outlays in various sectors acts
 as useful indicators towards possible investment opportunities. They focus towards the
potential demand for goods and services by the different sectors of the economy

Project formulation
The project formulation stage involves further analysis of the project to ensure that it has the
potential and the money that will be spent would yield good returns. It comprises the following:
1. Pre-feasibility study: A pre-feasibility study has the following main objectives:
(a) To determine whether the project offers a fruitful investment opportunity.
(6) To determine whether there are any aspects of the project, which are critical requiring
detailed investigation.
The preliminary feasibility study should examine the following:

(a) The market potential for the product/service, the competitors in the field and their
respective market shares, the trading practices in the industry, government controls,
etc.
(b) The technologies available and the suitable technology for the project, the various
manufacturing facilities required in terms of plant and machinery.
(c) The availability, source and cost of raw materials.
(d) The location of the plant.
(e) The plant capacity.
(The manpower requirements with their availability and cost details.
(g) The investment required and the return on investment expected, the means of
financing the project, the cost of production and commercial profitability.
If the pre-feasibility indicates certain grey areas of project that need a detailed study, such
studies are taken up before taking up feasibility study. Such studies are known as support
studies or functional studies.
2. Support studies (functional studies): Support studies may be conducted in any of the
following areas:
(a) Raw material/input study
b) Market study
(c) Plant size study
(d) Equipment selection study
(e) Project location study
Pre-feasibility study usually arrives at a conclusion, in case, the conclusion is that the
success of the venture depends upon successfully marketing the product in view of the
stiff competition prevailing, the need for the detailed market study arises. If the market
study reveals that marketing the proposed product successfully would be a difficult
proposition, then the project should be better shelved. Support studies can also be
undertaken simultaneously with a pre-feasibility study.
 commercial and financial
3. Feasibility study: study, the technical, economic,
In this
ascertained in concrete terms before taking the final
justification of the chosen project is
decision to take up the project.
that most of the projects get a thorough
(a) Technical feasibility: It is usually
seen

technical feasibility does not get the

examination on their financial prospects but the
activities, the technology
required attention. For projects involving manufacturingtechnical
consideration. The feasibility can be
proposed to be adapted needs careful
evaluated by answering the following questions:
and the latest?
Is the technologyproposed to be adapted the best available
will become obsolete in the
What are the chances that the proposed technology
near future?
Is the technology proposed to be adapted a proven technology?
Is the technology proposed to be adapted available indigenously?
In case of imported technology, is the technology available easily?
investment made on the
(b) Economic viability: Economic viability ascertains that the
or not. The major aspects
project will give a satisfactory return to the economy
which arelooked into are as to whether the project will make better use of available
use of some scarce
raw material, whether the project will reduce or eliminate the
resources, etc.

(c) Commercial viability: Before embarking upon any product or service, the scope for
assessed.
successfully marketing the product/service shall be carefully and accurately
market
Especially if the product/service proposed is new to the industry, systematic
a

survey is a prerequisite for assessing the probable

estimates of the likely sales. The
order to
likely sales estimated should be well above the proposed plant capacity in
overcome any pitfalls. In case of a product proposed to be manufactured is already
of
being manufactured by many others, the competitive edge can be gained in terms
quality, price and consumer acceptability, etc.
(d) Financial feasibility: The financial feasibility examines the viability of a project
in respect to raising finance to meet the investment required for the project. The
financial feasibility also consists of calculations of cost of debt, cost of procuring
the capital, cost of servicing the debt and equity and anticipating and evaluating
expected profits involved. If in feasibility analysis. the project is found feasible. the
same is put to further analysis.

44. Techno-economic analysis: Techno-economic analysis is the identification of the project

demand potential and selection of the optimal technology suitable for achieving the
project objectives. This analysis can be done through estimation of demand or potential
and selection of an appropriate technology.
5. Project design and network analysis: A project usually comprises certain sequential
form
activities which are interrelated with each other. Such activities can be shown in the
the
of a diagram, which is called network diagram. Project design is concerned with
development of a detailed work plan of the project comprising the time estimates. When
 a network s designed, its analysis is carried out to identify the optimal course of action
so as to complete the project with minimum time, cost and available resources. Some of
the network analysis techniques are PERT (Programme Evaluation Review Technique)
and CPM (Critical Path Method).
6. Input analysis: Input analysis is the identification, quantification and evaluation of
project inputs. The objective of input analysis is to identify the nature and quality of
resources needed to ensure that there is adequate supply of inputs. Input analysis is the
basis for financial analysis and cost benefit analysis.
7. Social cost benefit analysis: In social cost benefit analysis, the investment projects are
evaluated from the point of view of the society as a whole. The cost benefit analysis aims
at analysing the real contribution of an investment project towards the welfare of the
society. It implies the enumeration and evaluation of all the relevant costs and benefits. It
can be applied to both private and public investments.
8. Preparation ofproject report: After evaluating the project from various dimensions, the
entrepreneur prepares a detailed project report. The report acts as a blueprint which helps
the entrepreneur in the implementation stage. The report is also a necessary document to
gain financial assistanee from various agencies.

4.4 MARKET ANALYSIS

Market analysis involves the detailed study of various market segments in terms of customer
preferences, competitors, the untapped demand, the prevalent trade practices, etc. Before an
entrepreneur embarks upon his joumey of business, it is essential to analyse the project from
he market and demand perspectives.

4.1 Objectives of Market Analysis

1. To identify the depth and breadth of demand.
2. To detemine the flow of stock to be maintained in the market.

3. To determine the number, size and types of competitors in the

market.
4. To identify the customers status. buying capacity, preferences. etc.

4.5 DEMAND ANALYSIS

Demand analysis is a study that uses the data collected from primary and secondary sources
and determines if the proposed product or service will be successful in the market or not. These
studies can also be used to help find ways to increase the sales performance of the good or
Service in the future (Figure 4.1).
 Enuep eu

Collection of Primary Demand Forecasting

and Secondary
Information

Characterization of the
Situational Analysis and Market
Specifications of
Objectives

Market Planning

Conduct of Market
Survey

Figure 4.2 Market and Demard Analysis

4.5.1 Methods of Demand Analysis

To facilitate reliable appraisaB of an investment proposal, we require a reasonably accurate
forecast of demand. The various methods used for demand analysis are as follows:
1. Collective opinion survey: This method involves collecting opinion of customers. Each
salesperson makes an estimate of the expected sales in their respective area, territory, state
and/or region. These estimates are collected, reviewed and revised to take into account
changes in features or design of products, changes in selling prices, projected advertising,
sales promotion campaigns and anticipated changes in
competitors, marketing policies,
etc. Opinions of all the managers involved at various levels
of organization are also
included in the survey. Such collective opinions form the basis of market
demand forecasting.
analysis and
2. Survey of customers' intention: This method
surveys consumers' preferences and
intentions to buy. If the product is sold to large industrial
buyers, survey would involve
interviewing them. If it is a consumer durable product, a sample survey is carried out for
questioning a few representative consumers about what they are planning or intending to
buy. It is neither realistic nor desirable to query all consumers. These
surveys serve useful
purpose in establishing relationships between demand and
price.
3. Delphi method of demand
forecasting: Delphi method is a group decision-making
process and aims at achieving a 'consensus' of the members.
Herein experts in the
Project Planning 37
field of marketing rescarch and demand
forecasting areengaged in analysing economic
conditions carrying out sample surveys of market
conducting opinion polls.
(a) ldentify problem.
(b) Gather experts.
(c) Propose problem to experts.
(d) Record solution/recommendations from experts.
(e) Compile and summarize experts'
responses
() Share responses with all others.
(g) Collect experts' comment on others ideas and propose solution.
(h) Compile and present solutions.
4. Nominal group technique: This is a further modification of Delphi method of
forecasting. A panel of 7-10 experts is formed and allowed to interact, discuss and rank
all the suggestions in descending order as per the following procedure:
(a) Define the problem.
(b) Silently generate ideas.
(c) State and record ideas.
(d) Clarify each on the list.
(e) Rank items silently.
( Tally rankings. Group decision is announced based on this ranking.
Some other statistical methods of demand forecasting are Simple Average Method, etc.

4.6 MATERIAL BALANCE

Material balances is used for economic planning in which material supplies are accounted for
in natural units, as opposed to monetary terms, and are used to balance the supply of available
inputs with targeted outputs, In this method, a survey of available inputs and raw materials is
collected. After surveying input and raw material data, a balance sheet is used to balance them
with output targets specified by industry to achieve a balance between the supply and demand.
This balance is also used to formulate a plan for the national economy.

4.7 INPUT AND OUTPUT METHOD

It is a quantitative economic technique that shows the interdependencies between different
branches ofa national economy or different regional economies. This method is used to depict
38 from one industrial
showing how output
inter-industry matrix, columnn
within an economy,
relationships
the inter-industry industrial sector. In the

sector may
input to another
become an while row entries
represent outputs
industrial sector,
inputs to an
other sector, both as a
entries typically represent cach sector is on every
sector. This shows how dependent Each column represents the
from a given supplier of inputs.
other sectors and
as a
of outputs from cach row represents
each sector, and
value of inputs to
customer

matrix and the monetary

input/output
sector's outputs.
the value of cach

4.8 FIELD SURVEY

formulation stage. Collection and gathering of
used in the project
Field survey is a tool called field survey. Field
conducting primary surveys is
information at the local level by
out through observation, sketching
are used for geographic
enquiries. It is carried
surveys
measurement, interviews, etc.

4.8.1 Importance of Field Survey

field survey
be supplemented through a well-planned
1. Geographical enquiry is always to
distributions and their
about patterns of spatial
2. They enhance our understanding
associations and relationships at the local level.
level information that is not available through
3. They also facilitate the collection of local
secondary sources.

4 They study the problem under investigation in depth.

5. They help in comprehending the situation and processes in totality.

4.8.2 Steps in Conducting a Field Survey

.Step 1: First the problem to be studied is defined by using statements indicating the
nature of the problem. The problem becomes the title and subtitle of the topic of the
survey.
Step 2: The objectives and purpose ofthe survey are outlined and, in accordance to these.
suitable tools of acquisition of data and methods of analysis are chosen.
Step 3: After the definition of objectives and purpose now the scope of survey, the time
period of enquiry and the themes of studies to be covered are defined.
.Step 4: The information is collected using various tools. Various types of tools are
required to collect information. Information is recorded and published data from
government agencies, neld observalion data, interviewing. ete.

Step 5: Afier collecting the required information, it is then organized for its meaningiul
interpretation and analysIs.
S t e p 6: In the last step. the hcld study summary report is prepared and it contains all the

details of the procedures followed, methods, tools and techniques employed.

 39

SUMMARY
Project selection is the first cornerstone to be
laid down in
success or failure of an
setting up
enterprise. The
an
entrepreneur largely depends uponthe kind of project selected
Project is a schene, design or a proposal intended or devised to achieve a
It involves investment of money. Its particular aim.
goal is to earn profit. It deals with the production or
manufacturing goods and services. It has a definite beginning and an end
of

Projects can be classified into various

catcgories such as quantifiable and non
quantifiable. sectoral projects, and techno-economic projects. The projects can alsoo
be classified according to their age, experience and purpose, and also according to the
urgency of the execution
Project management is the process of planning, organizing. monitoring and controlling a
project and motivating all involved in a project to achieve project objectives within the
specified time, cost and performance
The process of project planning involves project identification, formulation. project
selection and appraisal
Market analysis involves the detailed study of various market segments in tems of customer
preferences, competitors, the untapped demand, the prevalent trade practices, ete.
Demand analysis is a study that uses the data collected from primary and secondary

sources and determines if the proposed product service will be successtul in the
or

market or not. There are various methods used for demand analysis like collective
opinion survey, Delphi method, etc.

Material balances is used for economic planning in which material supplies are accounted
to balance the supply of
for in natural un1ts, as opposed to monetary terms, and are used
available inputs with targeted outputs
that shows the intercdependecies
Input/outputmethod is a quantitative economic technique
different regional economies
between different branches of a national economy or
formulation stage. Collection and gathermg ot
Field survey is a tool used in the project
is called tield survey
information at the local level by conducting primary surveys
ProjectAppraisal
5
5
OBJECTIVES
wil be able to understand the following:
After going through this chapter, the student
The concept of project appraisal
The various elements of project appraisal
The methods of project appraisal1
The concept of a project report
.The rationale ofthe project report
The contents of a project report
The problems faced in the preparation of a project report

5.1 PROJECT APPRAISAL

The project has to be appraised in relation to the feasibility ofthe technical, economic, financial,
commercial, managerial, social and other aspects of the project. The purpose of a project
appraisal is to decide whether to accept or reject an investment proposal.

llustration 5.1 Technical Appraisal of Project

5.1.1 Elements of Project Appraisal
There are eight aspects of project appraisal. They are as folows:
1. Technical feasibility.
2. Economic viability.
3. Commercial viability.
4. Financial feasibility.
5. Managerial competence.
6. Social consideration.
7. Ecological analysis.
8. Project risk analysis.

5.1.2 Methods of Project Appraisal

The methods of project appraisal are described below:

Urgency mnethod
It is a method which is based on the degree of urgency or necessity. A project that cannot be

postponed is undertaken first. The merits of this method are:

1. It is a very simple technique.
2. It is useful only in case of short-term projects which require small investment.

The demerits of this method are:

1. Selection is based on situation and not on the basis of economical consideration.

2. It is not based on scientific analysis.

Payback method
is the length of time
It is a cash-based capital budgeting decision technique. Payback periodbreakeven of the
would be paid back. It is a point
required: a period over which the investment
investment. It is also called 'pay-out' or 'pay-off
project, where the accumulated returns equal
period or "recoupment' or "replacement period'.
When cash inflows/benefits are even or equal,
1. When annual cash inflows are equal:
payback period is calculated as
Costs of Project/lnvestment
PP Annual Cash Inflows
for 7
and annual net cash inflow is RI,00,000
For example, if cash outlay is 5,00,000
years, then

Payback period
= 5,00,000 =
5 years
1,00,000

investment is recovered with 5 years.

The whole cost of the original
N M
Project Appraisal 43

Average rate of return (ARR) method

the ratio of the average annual profits to the average investment in the
This method caleulates
project. It is based on accounting profits and not on cash flows. This method is also known as
accounting rate of return method or return on investment method or unadjusted rate of return
method.

Average profit after taxes

ARR
Average investment

Average investment
If the ARR is high, then the project is considered to be lucrative. If the projects are mutually
exclusive, the project with the highest rate of return would be selected. If the calculated ARR
is equal to or more than the company's target rate of return, the project will be
accepted. l
the calculated ARR is less than the company's target rate of return, the project will be totally
rejected.
Advantages of ARR:
It is simple to understand and easy to apply.
2. It considers eanings over the entire life of the project.
It also considers profitability of the investment.

4 Projects of different nature and character can be compared using this method.

5. Rate of return may be readily calculated if the accounting data is available.

Qisadvantages of ARR
1. It does not take into consideration the time value of money.
2. It does not differentiate between the size of the investment required for each project.

3. It is based upon only accounting profits, instead of cash flow.

4 It ignores the fact that profit can be reinvested.

Net present value (NPV) method
This method involves discounting future cash flows to present values. The cash outflow (ie.
initial investment whose present value is the same) is deducted from the sum of the present
values of future cash inflows (returns or benefits). The balance amount is NPV which can be
either positive or negative. If the NPV is positive, it would mean that the actual rate of retum is
more than the discount rate and that the project will contribute to the wealth of the shareholders.
the of
However, a negative NPV indicates that the project would not be able to cover cost

capital. It means that the actual rate of return is less than the discount rate.
rate of interest
Determination of minimum rate of return: To discount cash flows, a mininmum
rate of return
should be selected. This is generally the firm's cost of capital (i.e. the minimum
an investor expects from the firm to earn on the proposed investment).
PV=Cash inflow x Discount factor of the concerned period
 NPV--Co 1+r (1+ r) (1+r)
where
- C =Initial investment

C Cash Flow

r= Discount Rate

T Time

Box 5.2-Why is the NPV bigger when theinterest rateis lower?

Interest rate is like the team you are playing against, if you play an easy team (like a 6%
interest rate) then you look good; if you play a tougher team (like a 10% interest) then
you will not look so good!
You can actually use the interest rate as a "test' or "hurdle" for your investments:
demand that an investment has a positive NPV with, say, 6% interest.

The decision rule is that in case of a mutually exclusive or alternative project where ony
one project is to be selected, accept a project that has the highest positive NPV. In the case ol
individual investment, accept a project if its NPV is positive.
If the NPV is negative, reject it
Advantages of NPV
. It takes into account the time value of money.
2. it focuses attention the
on objective of maximization of the wealth of the project.
3. It considers the cash flow stream over the entire life of the
project.
ProjectAppraisa 45

T t is very useful im case

of mutually exclusive projects.
1tis best
suited when the cash
inflows are not uniform.
5
Disadvantages of NPV
I t involves complicated caleulations.
l t is dificult to select the discount rate.

I t is not suitable in case

of projects involving different amounts of investment.
The relative desirability of a project changes with a
change in the discount rate.
This method is not Suitable in case of two projects having different useful lives.

Renefit cost ratio (profitability index) method

When two projects have different investment outlays, they cannot be compared by NPV method
hecause it indicates the NPV in absolute terms. In such a situation, benefit cost ratio should be
annlied. It is the ratio of benefits (cash inflows) to cost (cash outflows). This method measures
pre
ent value of returns. This method is also known as profitability index or present value index
method.
Benefit cost ratio (BCR) is computed as follows:
BCRBx100

C
or

P l -Cx100
C
where PI is profitability index, B is gross discounted benefit and C is
gross discounted
cost.

The decision rule is: Accept the project if its PI is more than one and
reject if the project if
its Pl is less than one. In the case of
mutually exclusive projects, the project with higher Pl is to
be selected. The higher the
profitability index, the better is the project.
Advantages of BCR
.
Itis scientific and logical in nature
2. It is based on the real
profitability of projects.
. It is very useful in case of projects having different investments.
4. It also
reflects time value of money.
.It considers all cash flows
during the life of the project.
Disadvantages of BCR
i s comparatively difficult to understand.
This method is not in accordance with the
accounting prineiples.
 Entrepreneurship Developmen!
46
those projects which have unequal lives.
3. It cannot be used for comparing
estimate the effective life
of a project.
4. It is dificult to

Internal rate ofreturn (IRR)

flows is equal to the initiat
IRR is the which the total present value of future cash
rate at

investment incurred. In otherwords,

it is the rate at which NPV is zero. This rate is called
internal rate because it exclusively depends on the initial outlay and cash proceeds which are
associated with the project. Calculation of IRR: IRR is a time-adjusted rate of return which
cash outflow. The decision rule is thas
equates present value of cash inflows, with original
calculated IRR is compared with the desired minimum rate of return. If the IRR is greater than
the desired minimum rate of return, the project is accepted and if it is less than the desire
minimum rate of retum, then the project is rejected.
Given a collection of pairs (time, cash flow) involved in a project, the IRR would follow from
the NPV, as a function of the rate of return. A rate of return for which this function is zero is
the IRR.

In the Internal Rate of Return formula,

number of cash flows
CF=cash flow at period
IRR = Internal Rate of Return

0-or 1-0+ RR
i= IRR
1+IRR-IRR
= +CF
or

NPV
IRR =T
NPV,- NPV,
lower discount rate ckosen
higher discount rate chosen
N NPV at ra
N, NPV at rb

Advantages of IRR
. It considers all the cash flows over the entire life cycle of the project.
2. Cost of capital need not be calculated.
3. Itgives a correct picture of the profitability of the project.
4. Projects having different degrees of risk can easily be
5. It also takes into account the time value of
compared
money.
Project Appraisal
47
Disadvantages of IRR
1. It is difficult to
understand and use in practice because it involves
calculations. complicated
2 Sometimes it may yield confusing
negative rates or multiple rates.
3. It has applicability large projects.
for
4. It yields results inconsistent with
the NPV method if projects differ in their expectea
life.

5.2 PROJECT REPORT w www ww.w w w. ww SNONNOS8UKS *w..

A project report is a Written document with respect to any investment proposal based on certain
information and factual data for the purpose of appraising the project. It describes the business
intended to be undertaken by the entrepreneur in terms of feasibility, commercial viability and
social desirability. It is also used to formally communicate the project promoter's decision of
venturing a new project to financial institutions to government departments for getting their
approvals. A project report is prepared by an expert after a detailed analysis of the various
aspects of a project.

5.2.1 Objectives of a Project Report

The basic aim of a project report is to assess the financial viability of a project as well as the
soundness of its production, marketing and other related aspects. It has the following objectives:
1. It facilitates business planning.
2. It enables an entrepreneur to compare different investment proposals and select the most
feasible project.
3. It provides a SWOT analysis, wherein the strengths, weaknesses, opportunities and
threats involved in the projects are identified.
4. The project report enables the entrepreneur to ensure that he is proceeding in the right
direction.
S. It also enables the concerned authorities to take decisions.

6. It facilitates project evaluation and appraisal.

7. It helps the financial institutions to make appraisal as regards financial, economic and
technical feasibility.

5.2.2 Contents of a Project Report

The main contents of a project report are:
1. General information pertaining to the project.

. Background and experience of the project promoters.

 Entrepreneurship
urship Deveopinen
48
3. Details of the industrial concerns owned or promoted by the project promotere evelopmen
rs
4. Details of the proposed project including the following

(a) Plant capacity.

(b) Technical know-how.

(c) The manufacturing processes to be used.

(d) Details of the team involved in the project
(e)Details ofthe land, building, plant and machinery.
() Details of the infrastructural facilities required for the project.
(g) Raw material requirement/availability.
(h) Labour requirements/availability, etc.
5. Schedule of implementation of the
project.
6. The details of the costs involved in the
project.
7. The financers of the
project.
8. Working capital requirements.
9. Marketing and selling provisions.
10. Profitability and cash flow estimates.
11. Mode of
repayment of term loans.
12 Government approvals, local body consents and
other statutory
13. Details of collateral permissions.
security that will be offered to the financial
institution.
5.2.3 Problems Faced in
the
An
Preparation of a Project Report
entrepreneur may face the following
1. Strict problems in the preparation of a
conditions of
promoter' s contribution
project report:
2. All
lending institutions demand a lot of
may dampen enthusiasm of
the
3. Problems documents before credit is entrepreneurs
regarding working capital assessment due granted.
4. Time overrun to unrealistic

5.
will lead to cost
overrun. assumptions.
Lending institutions expect strict
their costs, specifications with regard to size
sources of
6. A number of
machinery, etc. of the land,
buildin
clearances have to be
causes strain and obtained from the
wastage among government departments. iThis
Figure 5.1 presents a entrepreneurs.
sample of a project report for a
manufacturing unit.
Project Appraisal

49
Project report for
PRODUCT DESCRIPTION
.
Manufacturing Unit.
2. PRODUCTION AND GENERAL
EVALUATION OF PROSPECTS:
3. MARKET ASPECTS
) Target users:
(ii) Sales Channels& Methods
of distribution:
(ii) Geographical Extent of
(iv) Competitive Situation: Market:
(a) Domestic Market
b) Export Market if any
(v) Market needed for plant described:
4.4. PRODUCTION REQUIREMENTS
() Annual Capacity
(i)
(ii) (One/Two/Three-Shift Operation)
Capital Requirements for Land &
Equipment, Furniture and fittings Buildings
on rent

Working capital
(ii) Total capital which the entreprencur would need for the
whole project:
(i) Own
(i) Borrowings (amount and sources)
(iv) Expected net profit per annum
5. CAPITAL REQUIREMENTS
i) Fixed assets and working capital
(a) Land (..sq. metres) and
Building (...sq. metres) (at Rs... Per annum)
(b) Equipment:
() Production Equipment
i) Other Tools& Equipment
(ii) Furniture and Fittings
(c) Working Capital (
i) Raw Material & Allied Supplies (Annual)

Deseription Qty. Rate Annual

Requirements
I. Material-1
2. Material-2
3. Material-3, etc.
4.
5. Power, Fuel & Water
6 Maintenance & spares
7 Other Supplies

Total
50 p e1ent

iii) Manpower (Annual)

Rate Annual
Deseription per month (Rs.) Cost Rs.
No.

Manager
Foreman
Supervisors
Skilled Workers
Semi-skilled Workers
Unskilled Workers
Office Staff
Others

Total

(iv) Other Costs (Annual)

(a) Depreciation on equipment, Furniture & Fittings/Annum
(b) Interest on Capital (fixed and working) per annum
(c) Administrative Costs
(d) Sales cost (Including sales Commission, Advertisement, etc.)
(e) Provision for discount, bad debts and miscellaneous
contingencies
(1) Training costs

6. Total Annual Costs, Sales Revenue and net profits

(a) Annual Costs
) Rent for Land & Buildings
(i) Raw materials and Allied
Supplies
(ii) Manpower
iv) Other Costs
(b) Annual Sales Revenue
(c) Expected Annual Net Profit (b -

a)
(d) % profit on Own
Capital
(e) %Profit on Total Annual Sales Turnover
( % on Total Investment

7. Remarks:

Signature

Date
Figure 5.1 A
Sample Project Report