UNIT - TIL BUSINESS PLAN PREPARATION > Project identification & Classification > Project Formulation > Project Design & Network analysis, > Project Appraisal Project Identification and Classification Meaning of Project Project classification Project identification Intemal and external constraints Project objectives Desk Research and Techno-economic Survey Project Life Cycle Review Questions Meaning of Project In the precise sense, a project presupposes commitment to tasks to be performed with well defined objectives, schedules and budget. It can be defined as a scientifically evolved work plan devised to achieve a specific objective within a specified period of time. taken in this perspective, while projects can differ in size, nature, objectives and complexity, they must all partake of three basic attributes of being a course of action, of having specific objectives and of involving a definite time perspective. From the point of view of resource allocation, a project can be considered as a proposal involving capital investment for the purpose of developing facilities to provide goods or services. A project may involve the establishment of new plant for the manufacture of steel ingots, it may involve the provision of additional educational facilities to a particular age group in the community, or it may aim at developing infrastructure facilities for the marketing of agricultural products. Whatever the nature of the project, a project will involve allocation and consumption of resources on the one hand and generation of resources, goods or services on the other. Webster New 20" Century Dictionary refers to it as a scheme, design, a proposal of something intended or devised. The Director of Management regards it as an investment project carried out according to a plan in order to achieve a definite objective within a certain time and 55 Crested with n nitro” cd the free talwhich will cease when the objective is achieve. Similarly, a project according to the Encyclopedia of Management, is an organized unit dedicated to the attainment of a goal the successful completion of a development project on time, within budget, in conformance with pre-determined programme specifications. Another schoo! of thought looks upon a project as a combination of interrelated activities to achieve a specific objective. For instance, a project according to Project Management Institute, USA, is a system involving the co-ordination of a number of separate department entities through the organization, and which must'be completed within prescribed schedules and time constraints. Project management scholars emphasis that a project a unique and non-repetitive activity aims at systematically coordinating inputs in the -direction of intended outputs. To quote Harrison, a project can be defined as a non-routine, non-repetitive, one-off undertaking normally with discrete time, financial and technical performance goals. ‘There are still others whose primary emphasis is on appraising investment proposals from the economic and social profitability angles. For instance, according to Little and Mirrlees, a project refers to any scheme, or part of a scheme, for investing resources which can reasonably be analysed and evaluated as an important unit. The Manual on Economic Development Projects too defines a project as the compilation of data which will enable all appraisal to be made of the economic advantages and the disadvantages attendant upon the allocation of county's resources to the production of specific goods and services. Thus, a project may be defined as a scientifically evolved work plan devised to achieve a specific objective within a specified period of time. The objective may be to create expand and/or develop certain facilities in order to increase the production of goods and/or services in the community. Project Classification Projects have been classified in various ways by different authorities. Little and Mirrelees divide the projects into two broad categories, viz., quantifiable projects and non- quantifiable projects. The Planning Commission has accepted the sectoral criteria for classification of projects. Projects can also be classified on the basis of techno-economic characteristics. All India financial institutions classify the projects on the basis of the nature of the project and its life cycle. The project classifications are explained below. 1. Quantifiable and non-quantifiable projects Quantifiable projects are those in which a plausible quantitative assessment of benefits can be made. Non-quantifiable projects are those where such an assessment is not possible. 56 re NY nitro™ professiona download te fre trl online tit enon xd withProject concerned with industrial development, power generation, mineral development are forming part of quantifiable projects. ‘The non-quantifiable projects category comprise health, education and defence. 2, Sectoral Projects According to the Indian Planning Commission, a project may fall in the following sectors : Agriculture and Allied Sector Irigation and Power Sector Industry and Mining Sector ‘Transport and Communication Sector Social Services Sector Miscellaneous Sector vvvVVV The sector classification of projects is quite useful for resource allocation at macro levels. 3. Techno-Economic Projects Techno-economic projects classification includes factors intensity-oriented classification, causation-oriented classification and magnitude-oriented classification. ‘These three groupings are narrated as under. (@) Factor intensity oriented classification : The factor intensity is used as base for classification of projects such as capita-intensive or labour-intensive which depends upon the large scale investments in plant and machinery or human resources. (b) Causation oriented classification : The causation-oriented project are determined based, on is causes namely demand based or raw material-based projects. The non-available of certain goods or services and consequent demand for such goods of services or the availability of certain raw materials, skills of other inputs is the dominant reason for starting the project. (©) Magnitude oriented classification : the size of investments forms the basis for magnitude- oriented projects. Projects may thus be classified based on its investment such as large- scale, mediumOscale and small-scale projects. Techno-economic characteristics-based classification is useful in facilitating the process of feasibility appraisal. United Nations and its specialized agencies use the Intemational Standard Industrial Classification of all economic activities (ISIC) in collection and compilation of economic data. Since this classification covers the entire field of human economic endeavour, it forms a useful basis for classification of projects, Economic activities are under this classification grouped into ten divisions, which are sub-divided into ninety sub-divisions. The divisions are: 87 Crested with NY nitro™ professiona download te fre trl online tit f id- Agriculture, Forestry, Hunting and Fishing Division 1 - Mining and Quarrying Division 2 & 3 > Manufacturing Division 4 - Construction Division 5 - __Blectricity, Gas, Water and Sanitary Services Commerce Transport - Services - Activities not adequately described Financial Institutions Classification : All India and State Financial Institutions classify the projects according to their age and experience and the purpose for which the project is being taken up. ‘They are as follow: @ New projects (i) Expansion projects ii) Modernisation projects (iv) Diversification projects The projects listed above are generally profit-oriented and the services oriented projects are classified as under: @ Welfare Projects Gi) Service Projects Gii) ‘Research and Development Projects (iv) Educational Projects Project Identification Project identification is concemed with the collection, compilation and analysis of economic data for the eventual purpose of locating possible opportunities for investment and with the development of the characteristics of such opportunities. Opportunities, according of Drucker are of three kinds additive, complementary and break-through. Additive opportunities are those opportunitics which enable the decision-maker to better utilize the existing resources without in any involving a change in the character of business. Complementary opportunities involve the introduction of new ideas and as such do lead to a certain amount of change in the existing structure. Break -through opportunities, on the other hand, involve fundamental changes in both the structure and character of business. Additive opportunities involve the least amount of disturbance to the existing state of affairs and hence the least amount of risk. The element of risk is more in other two opportunities. When the element of risk increases, it becomes more important to precisely define the scope and nature of project idea, to develop alternative solutions for achieving the project objectives and to select the best pussible approach 0 as to minimize both resource consumption and risks and to optimize the return or gains. Project identification can not be complete without identifying the characteristics of a project. Every project has three basic dimensions — inputs, outputs and social costs and benefits. The input characteristics define what the project will consume in terms of raw materials, energy, 58manpower, finance and organizational setup. ‘The nature and magnitude of each of these inputs must be determined in order to make the input characteristics explicit. The output characteristics of a project define what the project will generate in the form of goods and services, employment, revenue, etc. The quantity and quality of all these outputs should be clearly specified. “In addition to inputs and outputs every project has an impact on the society. It inevitably affects the current equilibriums of the demand and supply in the economy. It is necessary to evaluate carefully the sacrifice which the society will be required to make and the benefits that will accrue to the society from a given project.] Projects do not emerge themselves. The inputs to set up a project can come from different sources such as Governmental agencies, credit and financial institutions, non- governmental organizations like chambers of commerce and industry, inter-institutional groups, technical -consultancy organizations and international collaborations. Once the venture ideas have been developed by entrepreneurs by following one or combination of sources explained, ‘ these have to be screened and evaluated in a preliminary fashion on the basis of intemal and external constraints prior to being put to additional tests of pre-feasibility. This project identification comes to an end by laying down specific project objectives clearly and concisely and without any ambiguity so that these convey one and the same meaning to all concerned. Internal Constraints Internal constraints arise on account of the limitations of the management system, which will eventually be responsible for the implementation of a project. In India, the internal constraints for the entrepreneurs while venturing the projects comprise inputs, resources and outputs. These are narrated as under: (@ Entrepreneurs, while implementing the projects, rely more on outside consultants for Preparation of feasibility reports in the formulation of their projects. ‘The limitation on the part of entrepreneurs to provide inbuilt project services in the form of preparing feasibility reports is an important internal constraint in the early implementation of the project. (ii) For early implementation of projects within the budgeted cost and time schedule, all the entrepreneurs cannot develop independent project managements systems, organization structure, network analysis and other elements. In such a situation, the entrepreneurs inherent intemal constraints are developing well equipped project management strategies and tools while implementing them. 59 re NW nitro™ professiona download te fre trl online tit enon id withii) ay) Project goals and objectives lay down the main purpose for which an organization exists. Practically, project management team is not much involved with the determination of project objectives. Certainly, this will be another internal constraint for the project team to achieve the unrealistic objective, which is decided by the top ‘management personnel of the business. The availability of the necessary intemal project elements and resources are physical and non-physical resources. ‘The physical resources include finance, personnel, inventories and faculties, The non-physical resources are patents, secret processes, unique experience and skills. Both physical and non-physical resources are the important constraints for the entrepreneurs to make available at a time when the project implementation is in progress. External Constraints ‘The external constraints are also another important constraint for the entrepreneurs who venture into project implementation. The important external constraints are the project environments ‘comprising things, people and situations outside a project and also the size, nature, location and extent of the project constitute the environment of the project. The other tangible environment factors are namely social taboos, government policies and the state of capital markets. These are described as under: @ @) Gi) ‘The external environment factors like nature, size, location and the extent of project are the important limiting factors for the entrepreneurs when the project does not conform to the socio-economic objectives of the country. Government policies and regulations are another major hurdle for the entrepreneurs while implementing the projects. They are mainly in the form of delay in giving approval to the entrepreneurs in the medium of industrial licensing, foreign collaboration approval, CCI clearance, environmental clearance, foreign exchange permit, capital goods approval and import goods clearance. Financial institutions, banks are the important external financial source for the entrepreneurs while financing their projects. The financial institutions and commercial banks cumbersome producers and documentations system are important extemal constraints for the entrepreneurs in the form of delay in financing the projects. Crested with Pf nitro” pro! cd the free talProject Objectives Project objective is an important element in the project planning cycle. Project objectives are concerned with detining in a precise manner what the project is expected to achieve and to provide a measure of performance for the project as a whole. Objectives are the foundations on which the entire edifice of the project design is built. The essential requirements for project objectives are: (@) specific, not general; (b) not overly complex (©) measurable, tangible and verifiable (@) realistic and attainable (©) established within resource bounds (consistent with resources available or anticipated (g) consistent with organizational plans, policies and procedures. The project objectives are aimed to complete the project on time, completion of the project within contemplated costs and the completion of the project at a profit to the company. Project objectives are divided into two categories, namely, ‘retentive’ objectives and ‘acquisitive’ objectives. Retentive objectives are concemed with the relation and preservation of resources like money, time, energy, equipment and skills. Acquisitive objectives, on the other hand, involve acquisition of resources or attaining states that the organization or its managers do not have. Project objectives are also economical and social in nature, The economical objectives of the Project are ion the form of profit-oriented. The social project objectives are service-oriented. The economical objectives are primarily concerned only with the primary financial costs and benefits of the project. It quantified the resources, which the project will consume in the shape of capital expenditure and maintenance expenditure, The social project objectives are inconformity with social cost benefit aspects of individual projects. The social project objective is the process of evaluating a project from the point of view of the total impact, which the project will have on the economy of the nation. Projects are to start with certain objectives to achieve specified results within the specified periods of time. Besides the specified results, which in effect are a generalized statement of Project objectives, projects achieve a number of other goals. The project formulation team should therefore try to locate as many consequences of the project activities as possible and thereafter take up the exercise of re-setting and re-defining the project objectives in unambiguous precise and as far as possible in quantitative terms. The process of project development involves a stage-by-stage development of the project idea into an investment proposition of the ensuring stage. ‘These conclusions also provide necessary 61 Crested with NY nitro™ professiona download te fre trl online titmaterial for re-checking of the initial premises from which a beginning was made. At the completion of each stage, the project team should, therefore, look not only forward but also backward. The backward look is necessary to recheck and if necessary modify the initial assumptions The project team has to be ready to revise its opinions and conclusions in the light of further evidence. In fact, the success of the tem will depend on its persistence and alertness on the one hand and on its intent to be as objective as possible on the other. Desk Research and Techno-Economic Survey Desk research and techno-economic survey are two important techniques of project identification. Desk research implies the collection and use of information from published sources like journals, magazines, reports, etc. Techno-economic survey is an investigation conducted by a team of experts for identifying the industrial development potential of an area. Central and State Government agencies often commission such surveys. Data and product identification may be obtained from the following sources: (Industrial potential surveys (ii) Lead bank survey reports (iii), New process/product development in research laboratories (iv) Literature on industries within the country and abroad (v) _Import/export statistics (vi) Profitability studies of selected industries (vii) Studies on price and shortage of certain commodities ‘A distinction should be made here between demand-based industries and resource-based industries, Demand-based industries are those whose products and services are required by the existing industries as raw materials and component parts. For example large projects like BHEL, Maruti Udyong, etc. require a large number of items. The fortunes of an ancillary unit are linked to that of the parent unit. Therefore, detailed analysis of the parent unit, experience of existing ancillary units, etc should be made before setting up an ancillary. For setting up a workshop or service unit also the market demand, local competition, availability of orders, etc. should be carefully judged. Central and State government have reserved several items for exclusive purchase from the small scale sector. Units for this purpose also come under the category of ‘demand-based industries. In the selection of resource-based industries, the availability of the necessary ‘inputs must be ensured. For example, a rice bran oil mill can be set up near rice mills a poultry feed unit near oil mills, and so on. This will ensure the availability of the necessary raw materials. ‘An entrepreneur can think of setting up an import substitution industry. The Government encourages such units. However, the Government's import policy, present demand, landed price 62 Created with NW nitro™ professiona download te fre trl online titof the imported item, quality differences, etc. should be considered. The demand and supply estimates should include the licenses already granted and in the process of being established, capacity utilization of the existing units could be taken as a broad ‘indicator of market for.the product. Import statistics available from Government publications should also be analyzed for the purpose Similarly, export-oriented units are given preference by the Government. Export statistic, demand potential of foreign markets and other relevant issues must be considered before choosing an export-oriented unit. Project Life Cycle Like human beings, projects also have a life cycle. Project life cycle consists of three main stages: 1 The Pre-investment Phase : This is the first phase in the life of project. It is primarily concemed with objective formulation, demand forecasting, selection Of optimal strategy, evaluation of input characteristics, projections of the financial profile, and if necessary cost benefit analysis and ultimately the pre- investment appraisal. The project idea is developed into an investment proposition during this phase. 2 The Construction Phase : This phase begins after the investment decision is taken, Resources are invested during this phase in building the basic assets of the project, which can in due course be utilized to achieve the project objectives. The assets may be in the nature of land and buildings, plant and machinery, ancillary accommodation, communication services, control systems and marketing organization. In projects not involving the use of plant and machinery, the construction phase may merely consist of developing necessary manpower resources. Thus, the construction phase consists mainly of development the infrastructure for the project. It is a one time effort, a The Normalization phase : This phase starts after the trial run of the project framework developed during the construction phase. It involves routine procedures which are performed in a cycle order. The primary objective of this phase is to produce the goods and services for which the project was established. For this purpose, a provision has to be made for raw materials and other consumables. These can be determined by analyzing the process cycle identifying the sequence of process operations. Projects which do not involve Production of goods do not require raw materials but only supplies or supporting goods needed to sustain the project process. Thus, the assets created during the construction phase are utilized during the normalization phase. 63 Crested with NW nitro™ professiona download te fre trl online titPyojget Formulation Need Fef r1ojec: £0: sautation . The entrepreneur in a developing has to encounter a number of problems while establishing a “new project. These problems cause greater concem to many enthusiastic entrepreneurs. However, they could be saved to a greater extend by undertaking a project formulation exercise at the appropriate time. 1. Selection of appropriate technology: The first problem faced by an entrepreneur is in the matter of selection of appropriate technology for his enterprise. Modem technology developed in the highly industrialized countries may not be suitable for adoption in the developing countries as the conditions prevalent differ from country to country. For example, the optional size of plants recommended for a highly industrialized country may be too big for acceptance in a developing country owing to the factors such as limited market for the products and limited availability of capital and skilled labour. Hence, the entrepreneur has to examine the project idea thoroughly as regards its design production, marketing, after sales services, etc. 2. Influence of External Economics: The second problem relates to the absence or non- availability of extemal economies. No project can function in isolation in any economy. It has to depend on other industries for the supply of raw materials, power, tools, spare parts, etc., or on ancillary enterprises which can provide technical, financial and managerial services or on a complex net-work of communication and transport facilities or an intricate system of business practices. The entrepreneur in developing countries is, therefore, to consider not only the basic costs of the project but also the ancillary costs which in industrially advanced countries would have been contributed by the external economies. 3. Dearth of Technically Qualified Personnel: The third problem is the non-availability of technically qualified and appropriate personnel. Modern technology calls for a certain minimum supply of various skills that are generally lacking in developing countries. 4, Resource mobilization: The fourth problem is resource mobilization. In the context of present day development of the magnitude and size of project it would be very difficult for an entrepreneur to provide the entire development capital that a project may need. 5. Knowledge about Government Regulations: Besides these problems the entrepreneur has to comprehend a number of Government directives, import and export policies, price controls, etc. The difficult is to be familiar with all these regulations, for they are not available in a consolidated and detailed form in most of the developing countries. However, in India, a compendium entitled ‘Guidelines for Industries’ has been published 64 re NW nitro™ professiona download te fre trl online tit enon id withby the Ministry of Industrial Development. It provides information regarding the industrial policy, licensing procedures, guidelines for foreign collaboration, import and export control orders and foreign exchange orders. It also has information regarding the present status of capacities and possibilities of future development in various industrial fields like metallurgical industries, electronics equipment industries, transportation industries and the like. These problems make the entrepreneur to undergo a lot of harassment, disappointment and despair. However, a project formulation exercise undertaken at the right time mitigates the severity as well as magnitude of these problems. Concept of Project Formulation Project formulation is the systematic development of a project idea for the eventual objective of arriving at an investment decision. It has the built-in mechanism of ringing the danger bell at the earliest possible stage of resource utilization. Project formulation involves a step-by-step investigation and development of project idea. And it provides a controlled mechanism for restricting expenditure can exercise his discretion of calling off the exercise if the facts so warrant. It enables him to take decisions in a scientific way providing a concrete set of facts. Project formulation is a process involving the joint efforts of a team of experts. Each member of the team should be familiar with the broad strategy, objectives and other ingredients of the project. Besides being an expert in his area of specialization, he should be able to play his role in the overall, scheme of things. The government official who deals with the project’s final clearance has to’. tieated as forming part of the team. He should be well informed about the project. A well formulated feasibility report provides a medium which cuts across scientific, social and positional prejudices and provides a common meeting ground for all those who have a contribution to make in successful implementation of project. Project team should consist of experts in major substantive fields of the project. Depending on the situation any large project should comprise the following team menibers. (a) One industrial economist (b) One market a analyst (©) One or more technologist/engineer specializing in the appropriate industry (@) One mechanical and/or industrial engineer (©) One civil engineer, if needed (©) One management accounting expert. 65 Crested with W nitro” profe the free tal online at itSignificance of Project Formulation A well-formulated project is the best passport for obtaining the required assistance from financial institutions When there is a situation of resource constraint and the aygilable resources are allocated to various projects based on their importance and viability 1 well formulated project formulation is the best way of selling a project idea to a financing agency. * Project formulation will also be of great assistance for obtaining necessary Government sanctions have to be obtained and also provide an independent assessment of the feasibility of obtaining these sanctions based on the existing Government policies. The project report submitted by the entrepreneur will establish his bona fides in the eyes of the bureaucracy and obtain the due Government sanction without much difficulties. Elements of Project Formulation Project formulation is by itself an analytical management aid. It enables the entrepreneur to arrive at the most effective project decision. Project formulation exercise normally includes such aspects as follows: Feasibility Analysis ‘Techno-economic Analysis Project Design and Network Analysis Input Analysis Financial Analysis Social Cost-Benefit Analysis, and Project Appraisal. NoavaeNe Feasibility Analysis Feasibility analysis is the process of evaluating the future of a project idea within the limitauons of the proiect implementing body and the constraints imposed on the project situation by the environment. The analysis is undertaken to determine the desirability of investing in further development of projéct ideal When a project is taken up for development three alternatives can arise. First, the project many appear to be positive and in such a case the project assessing body can proceed to invest further resources in pre-investment studies and design development. Secondly, the project may tum out to be not feasible and, therefore, further investment in the project idea is ruled out. Thirdly, the data is not adequate for arriving at a decision about the feasibility of the project. In such a situation, additional information must be collected and the investment decision is deferred till the final decision Projects identified are normally analyzed in order to establish their viability from different angles such as technical, marketing, financial, etc. In other words, the various Crested with W nitro” profe the free tal online at it falternatives in marketing, technology and other considerations ate studied and then findings, with the supporting data, are presented in a systematic form. Generally, the exercise in project feasibility analysis is caried out dividing it formally into thre stages, viz., prefeasi lity study, feasibility study and project repost. (h) Prefeasibility Study : The project idea must be elaborated in a more detailed study. However, formulation of a techno-economie feasibility study that enables 4 denmite decision to be made on the project is a costly and time-consuming task Therefore, before assigning funds for such a study, a preliminary assessment of the project idea must be made in a pre-feasibility study. The principal objectives of such a study are to determine whether: (a) The investment Spportunily is 80 promising that an investment decision can be taken on the basis of information claborated at the pre-feasibility study; (b) The project concept justifies a detailed analysis by a bre feasibility study; (c) Any aspects of the project are critical to its feasibility and neessitte x depth investigation through functional or support studies such as market surveys, laboratory {ests pilot plant tests; (4) The information is adequate to decide that the project is not either viable proposition or attractive enough for a particular investor or investor group. A reversibility study differs from a detailed feasibility study Primarily with regard to the detail of the information obtained. Even at the pre-feasibility stage it is necessary to examine, perhaps broadly, the economic altematives of: (a) Market and plant capacity; (b) Material input; (©) Location and site; (@) Project engineering; technologies and equipment and civil engineering works; (©) Overheads; factory, administration and sales; () Manpower; labour and staff, (g) Project implementation; (h) Financial analysis investment costs, project financing, production costs and commercial profitability. (i) Feasibility Study : It is the most important part of project analysis, for it Provides answers to questions in detail on different aspects relating to a project. In Practice this means investigating the project form six different aspects economic, technical, managerial, organizational, commercial and financial. ‘The relative importance of these different aspects varies considerably according to the type of Project involved. For example, in the analysis of public sector projects more importance is usually given product together with alternative approsches to such Production. Such a study should also provide a project of defined production capacity at a selected location using a particular technology or technology or technologies in 67 Crested with fp nitro profe the free tral online attrelation to defined materials and inputs, at identified investment and production costs, and sales revenues yielding a defined return on investment. ‘The feasibility study is an iterative process covering all aspects of an investment project such as possible altemative solutions for production programmes, luvations, technology, organizational setup, etc. If the resulting data show a non-vaible project, several parameters and the production programmes, material inputs or technology should be adjusted in an attempt to present a well defined viable project. ‘The feasibility study should describe this optimization process, justify the assumptions made and the solutions selected and define the scope of the project as the integration of the selected partial alternatives. If however, the project is not viable despite all alterations reviewed, this should be stated and justified in the study. ‘Most of feasibility studies have the same or similar coverage, though there may he considerable differences in orientation and emphasis depending on such factors as the nature of the industry, the magnitude and complexity of the production unit contemplated, investment and other costs involved. By and large, however, a satisfactory feasibility study must analyze all the asic components and implications of an industrial project and any shortfall in this regard will limit the utility of the study. 2. Techno-Economic Analysis fechno-economic analysis is primarily concemed with the identification of the project demana.potential and the selection of the optimal technology suitable for achieving the project objectives. (This analysis produces necessary information on which the project design can be based. It also indicates whether the economy is in a position to absorb the output of the project. The size of the project and the technology used depend very much on the demand potential. Technology, in a border sense, includes methodology or process where the technical operations are not included. An optimal size and technology enable to achieve the economies of scale, The techno-economic analysis, therefore, consists of two parts. The first part is concerned with the determination of the maximum feasible project output and the second part with the selection of the optimal strategy to match this output. (i Determination of Project Demand Potential : Estimation of demand potential is the starting point of techno-economic analysis. Demand forecasting helps to firm up the qualitative parameters of the project and also provides a basis for selecting the optimal strategy for the project. The forecasting may be for a short period extending up to a year i.e., short-run forecast or ma cover only a particular industry i.e., industry forecast. Or it may new personal or specific be relating to the nature of product, viz., new or established product ot the classification of product, viz., capital goods, consumer goods or services, etc., or the special features particular to the product, viz., market competition, risks associated with the product, etc. Crested with NW nitro™ professiona the free tal online at it fDemand forecasting involves determination of market characteristics, quantitative market analysis and appraisal of project demand potential. The identification of market characteristics is essential to arrive at realistic demand estimates and also to undertake quantitative market analysis. On the basis of their structural features markets may be divided into several distinct groups such as monopoly, oligopoly, monopolistic competition, pure competition, monophony ete, ‘The quantitative market analysis is made to estimate the industry demand of goods and services which a project may be expected to produce and to produce necessary information for developing project demand forecasts. The analysis is taken up in three stages: (a) Situation analysis, (b) Data collection and compilation, and (©) Interpretation and presentation. Situation analysis establishes the parameters of the quantitative analysis, It involves a study of the feasibility appraisal of the project with a view to establishing the specific purpose of undertaking the market analysis and identifying the dimensions of the demand forecasts. It also helps in assessing and eventually determining the desired alternatives of the demand forecasts, Demand forecasting involves the collection, compilation and interpretation of a large variety of statistical data. For projecting future trends, it is essential to know about past events, the situation at present and about the factors likely to affect the future course of events. Personal observation, desk research and market surveys are the commonly used ways for collecting data. Primary as well as secondary sources may be used for data collection, The data collected from various sources are first compiled, tested and tabulated in a form suitable for interpretation. It is then used for projection of future demand. (i) Selection of optimal project strategy : In any project situation, normally, an infinite series of strategies can theoretically be made available for achieving the Project objectives. The difference in the payoff of several of these strategies will be generally so small that for the purpose of decision making, a group of these strategies can be represented by a single representative strategy. This, on the one hand, facilitates the process of identification of feasible strategies and on the other simplifies the decision problem. The search for alternative strategies will be both time and resource consuming, Two types of cost are involved in the search problem viz., cost of the search itself and cost of the error. ‘The sample size, the sample design and the analysis of data are the controlled variables here. At the stage of selection of project strategy the project formulation team should have information about 69 Crested with 1 nitro” profe the free tal online at itthe project objectives, project feasibility parameters and the project demand potential. The feasibility parameter and demand potentials jointly determine the project feasibility horizon such as project size, capital investment, technology, etc. Project formulation, in order to be realistic, has to identify all feasible alternative courses of action so as to evolve the best strategy for a project. ‘A measure of performance is essential to develop a criterion of choice. Once it is developed, the benefits of various courses of action can be stated in terms of common measure of value and used for the selection of the optimal course of action. A project situation generally envisages the achievement of a number of secondary objectives such as creation of additional employment, removal of regional disparities, etc., in addition to the primary objective. Project formation is primarily concemed with the realization of these ultimate objectives. Since payoffs for all the courses of action are of the same nature, these can all be expressed in terms of one scale of measurement. A particular course of action will be selected on the basis of effectiveness in the attainment of the end objectives. Optimal project strategy refers to that combination of controlled variables which will ensure the achievement of the project objectives with minimum expenditure of resources. Ordinarily, within the feasible spectrum of project objectives, an infinite number of project strategies is available. At the outset, the selection of optimal stratey may appear to be difficult. However, the project demand potential, the internal constraints and external constraints of the project help to reduce the number of possible strategies considerably. ‘The optimal strategy may be selected by comparing the representative strategies and identifying the optimal representative strategy which meets the project ends in hand. The techno-economic appraisal report contains the recommendations of the project formulation team regarding the strategy which should form the basis for further development of the project idea. Since the process of selection of project strategy is based on analytical considerations, the report also contains the details of the reasoning on which the recommendations are based. The contents of techno-economic analysis report will include preliminary status of the work at the beginning, project objectives, project demand potential, possible altemative course of action and optimal strategy and finally the techno-economic appraisal. . Project Design and Network Analysis Project design is the heart of a project. It defines the individual activities comprising a project and the interrelationship between these activities. It identifies the flow of events which must take place before a project can start yielding the desired results. The inter-relationship between various constituent activities of a project is generally depicted in the form of a network diagram. 10 re NY nitro™ professiona download te fre trl online tit enon xd withProject design and network analysis are concemed primarily with the development of the detailed work plan of the project and its time profile. This plan is presented in the form of a network diagram. Network analysis is carried out to identify the optimal course of action, so as to execute the project within the minimum time keeping in view the available resources’ Thus, project design and network analysis paves the way for detailed identification and quanafication of the project inputs which is a essential for developing the financial and cost-benefit profile of a project. 4, Input Analysis After a project idea has withstood the tests of feasibility analysis, techno-economic analysis and network analysis, it become4s necessary to determine the resource requirements of the project. Input analysis is primarily concemed with the identification, quantification and evaluation of project inputs. The objective is first to identify the nature of the resources that a project will consume, secondly to estimate the magnitude of the required resources and thirdly to evaluate the possibility of un-interrupted supply of inputs. » Resources are needed in all the three phases of a project. But the nafure and amount of Tesources required differ widely from one phase to another. During the preinvestment stage resources are needed for investigating various aspects of the project idea and for developing the project design. During the construction stage, non-recurring resources arc necded to develop the project structure. During the normalization stage, the project requires raw materials and other consumables on recurring basis. The preinvestment stage generally consumes the least and the construction stage the maximum amount of resources. ‘The best method of determining the inputs is to identify the resources required in the various activities involved in the project. Resources required for a project consist of both material and human resources. Input analysis uses the network plan for developing the input characteristics of the project. Both recurring and non-recurring resources must be considered. Input requirements constitute the basis of cost estimates of the project and are, therefore, essential for developing the financial profile and the cost benefit profile of the project. 5, Financial Analysis Financial characteristics of an investment proposition have a significant impact on the acceptability or otherwise of a project. The purpose of financial analysis is to identify these characteristi¢s and to determine the financial feasibility of a project. Such analysis involves estimates about project costs and revenues and the funds required for the projec’ It seeks to find out whether the project will generate revenue to realize the ultimate objective for which it is undertaken. It reduces investment propositions to one common scale so as to permit comparison and eventual investment decision. Since investment proposition has a long time-horizon, due care and foresight must be used in financial analysis could be used for employing commercial profitability analysis. It could be made more effective by using break-even analysis and ratio n Crested with NW nitro™ professiona download te fre trl online titanalysis. It generates data for computing different profitability criteria with a view to establish the project’s. 6. Cost Benefit Analysis Under this analysis, estimates of social costs and social benefits are made and presented for computation of social profitability of the project. While the costs and benefits under the financial analysis are estimated employing market prices based on financial objectives, this cost- benefit analysis considers them only at certain imputed prices based on social or national objectives. Generally, the purpose of this analysis would be to ascertain all social costs and secondary benefits with a view to find out the impact of the project on the society. The methods of estimating the shadow prices or imputed prices, social discount rate, etc., are to be explained and the calculations are to be presented in separate statements or tables: However, most of the data obtained from financial analysis could be objected to reflect the true social values and use. Similarly most of the decision criteria techniques of the profitability analysis could be used also mefit analysis. The information gathered would be used mostly for setting the social profitability criteria for public sector project appraisal and evaluation. Social cost benefit analysis is now an internationally recognized system of project appraisal even though no standard methodology is available for it. ‘The results of the feasibility analysis, the techno-economic analysis, the design and network analysis, the input analysis, the financial analysis and the cost benefit analysis are consolidated so as to give a final and formal shape to the project. It involves selection of the appraisal format, its contents and form of presentation. It is known as pre-investment appraisal and its purpose is to enable the concemed authorities to take an investment decision about the project. Feasibility Report The details gathered from feasibility studies and presented in various reports and statements are consolidated into one master report called project report or feasibility report. This report also contains some background submitting the report. The main purpose of the report is to provide information that is required for the project appraisal in the case of public sector projects this report would also enable the concerned authorities to take an objective decision on the project. In addition, this report would enable the financing agencies to purposefully evaluate the project before extending financial assistance. Project Formulation Vs. Detailed Project Report ‘The difference between project formulation and preparation of the detailed project report should be clearly understood. Project formulation is an investigating process which precedes investment decision. Its purpose is to present relevant facts before the decision makers to enable n Crested with nitro” pro! cd the free tral ontthem to accept or reject the project. Therefore, the project idea is examined from the viewpoint of overall objectives, financial viability, technical feasibility and social impact. On the other hand, detailed project report preparation is a post-investment decision. It involves the preparation of detailed specifications and designs, engineering drawings, site investigation, foundations design and process design as well as time schedules for project implementation. Detailed project report (DPR) serves as the work plan for the implementation of a project whereas project formulation and pre investment report (PIR) is the basis on which the investment decision is taken. ‘Thus, project formulation always precedes detailed project report. Project Selection Project ideas identified earlier are screened on the basis of their technical, economic and financial soundness. After screening the ideas are translated into project profiles. A project profile consists of the following broad items. Economic size Status of industry or scope Raw material availability Cost of production Capital cost Utility requirements Infrastructure facilities needed Profitability Government policy. Sen avaene After gathering a large number of project profiles, the entrepreneur is faced with the problem of selecting the most appropriate project. ‘The following criteria may be used for this purpose. @ Investment size : Investment size depends upon the entrepreneur's capacity to raise Tesources and his attitude towards economic of scale. If the project is to be financed through all-India institutions with lesser promoter’s contribution, the project cost should be at least Rs. 3 to 5 crores. Gi) Location : A new entrepreneur should as far as possible locate his project in and around a state headquarters. Such a location helps to attract competent managers and facilitates 3 Crested with 1) nitro” prof cd the free talProject Design and Network Design Project Design Project design is the heart of the project entity. It defines the individual activities which go into the corpus of the project and their interrelationship with each other. Project design enables to identify the flow of events, which must take place for the successfii competitions of the project. ‘The inter-relationship between various constituent activities of a project is most conveniently exposed in the form of a network diagram. Need For Network Analysis Project formulation and its implementation are the two essential functions in project management. While project formulation is essential for the scientific selection of a project, its proper implementation ensures an optional allocation of time and resources to the various project activities. Project design and Network Analysis are important tools for the effective implementation of a project. Project design and Network Analysis are primarily concerned with the development of a detailed work plan of the project and its time profile, and the presentation of this pian in the form of a detailed Network Diagram. Project design defines the individual activities, which go into the corpus of the project and their inter-relationship with each other. It identified the flow of events, which must take place before a project can start yielding results for which it has been set up. Network analysis involves the consideration of the time and resources profile of the project activities so as to identify the optimal course of action involving the amount of time, keeping in view the available resource constraints. It provides the project formulation team a clear picture of the work elements of the project and also their sequential relationship. This presentation paves the way for a detailed identification and quantification of project inputs which is an essential step in the development of the financial and cost-benefit profile of the project study. Network Plauning Techniques A project consists of a number of constituent activities. it is examined in detail and the details are utilized to compile the sequential narration of the constitution activities of a project. lation is known as the project logic. When it is represented is the form of a graphical is called the network. ‘A network generally comprises a set of symbols connected with each other in a sequential relationship with each setup making the completion of an even. The network diagram and 14 Created with @ nitro™ professio download te fre trl online stop a Nescheduling computations enable the project formulation team to identify the longest series of activities through the project implementation phase, which determines the project duration. Classification of Network Techniques A number of network techniques have been developed and some of them are given below: CPM: The Critical Path Method is the logical mathematical model of the project based upon the optimal duration required for each activity and optimal use of available limited resources. It is a deterministic model. PERT: The programme Evaluation and Review Technique is primarily a scheduling technique. It shows any job or project as a set of processes of operation called ‘activities’ which must take place in a certain sequence. All activities have to be completed in order to accomplish the project. It is a probabilistic model and introduces uncertainties in project network. GERT: The Graphical Evaluation and Review Technique is a more recently used technique. This is superior to CPM and PERT. It allows for probabilistic events while all the events in CPM and PERT are deterministic. In the networks representing research and development project the process is repeated till the desired outcome is achieved. CPM and PERT cannot be used is such situations. In GERT network only simulation can be used. LOB: Line of Balance uses graphic techniques to show the progress achieved on the project with respect to key events. Cash flow costs and benefits The Flow of Private Capital Quantitatively, foreign private capital has not been very significant since Independence. Between July 1948 and December 1961, some Rs 438 crores of non-banking investments from private sources flowed into India, 1 compared with slightly less than Rs 2,000 crores utilized from public sources, 2 a ratio of 1:4.6. These are gross flows. Allowing for repatriation of investments and repayments of principal, the net inflow amounted to about Rs 307 crores3 and Rs 1,800 crores4 respectively, a ratio of 1: 6. The flows are not fully comparable; public funds arise abroad in their entirety; private investments originate partly in India as reinvested profits. About Rs 176 crores, more than two-fifths of the gross private flow took this form, the remainder-the ‘fresh capital’-dividing unevenly between investment in kind and in cash in the ratio of 3: 1. As can be expected from its narrow spread the private flow is heavily dependent on the fortunes of two or three industries. 5The course of petroleum investments alone offers an almost complete explanation of its behaviour, particularly since 1954; while invest-ments in a handful of other industries are enough to fill out the remaining discrepancies. This is shown in Table 17, p. 301. 1. An estimated Rs 188 crores up to December 1953, made up of Rs 33 crores in cash, Rs 85 crores in kind, and Rs 70 crores in retained earnings (RBI, Survey 1953, p. 84; ‘Recent Trends in Foreign Investment in India’, RBI Bulletin, September 1958, Table 2, p. 1010); and Rs 250 crores in 1954-61 inclusive (RBI, Survey 1961, Table VII, p. 34). The figures are adjusted ‘wherever possible’ for valuation changes. The total for 1948-53 is higher by Rs 8-13 crores than the Bank’s early estimate (as given in Survey 1953, loco cit.) but is based partly on its own later figures. Excess Capital Imports Evidence: Private imports were grossly over-licensed in t he initial stages of both the Second and Third Five- Year Plans and private investments rose well above projected levels Neither could have occurred had foreign investment always complied with either the Government’s own scaie of priorities or an efficient allocation of scarce resources and foreign exchange. Needless to say all foreign investments add to India’s liabilities abroad. Marginal spheres: There are a number of obvious sources of excess capital imports. Some projects-in soft drinks, ink, ball-point pens, tooth-paste and -brushes, and razor blades, for example are marginal by any standards. Other consumer products-fom rayon filament to domestic refrigerators-are scarcely less marginal in a development context. Price mark-up: Secondly, the value of many investments is inflated by marking up the prices of goods or materials or services supplied as investment in kind. This is done for a number of reasons, two of which are particularly important: a foreign collaborator might wish to bump up the ‘necessary’ import content of a project in order to establish title to a controlling interest] Altematively, as has long been the case in major sectors such as oil, tea, and many ‘manufacturing industries, the foreign investor might wish to mask his real level of profits by multiplying the forms and adjusting the levels of other payments. ‘A number of such cases came to light in private conversation. They rest as much on the authorities’ liberal interpretation of what is ‘necessary’ as on their declared policy of allowing foreign ownership to the limit of the foreign-exchange component of an investment. See above, pp. 226 If. Technology: Thirdly, there is the use of unsuitable foreign machinery. While there is an unanswerable case for a backward country to use the most productive techniques available in order to raise its capacity to save and invest, or because they are indispensable in the production of certain important end items or qualities, not all techniques are equally suitable. By importing a technology, lock, stock and barrel, a backward country might easily saddle itself with apparatus 16 Crested with NW nitro™ professiona the free tral online att fthat requires too sophisticated a network of servicing and ancillary industries or that cannot be justified in terms of its wage levels. This is particularly wasteful in consumer industries. And so it is in India, In many cases, the paper industry for example, imported Western techniques are inefficiently used in others, motor vehicles for example. they have imposed a wasteful pattern of fashion-induced changes utterly alien to Indian conditions. Personal obser-vation suggests large areas, particularly in packing and handling, in which machinery has displaced manual labour at great expense. The foreign investor is clearly not to blame for so widespread a phenomenon. Other factors include the lack of indigenous equip- ‘ment, the scarcity of managers, the desire to employ the minimum of labour where retrenchment is inhibited, the rise in labour costs and the decline in skill differentials since the war, the overvaluation of the rupee, and the need to compete abroad and at home against units more endowed with capital resources. But the fact that the foreign investor normally has a direct interest in supplying equipment and knowhow; is almost universally in charge of the technical operation of a joint venture; is often chary of imparting skills or development information; is very often ignorant about Indian conditions; and might wish to keep out equipment that can be copied easily-mean that the natural tendency to over-import techniques receives power-ful reinforcement. Duplication... Of all reasons to import capital in excess of real needs, the most compelling perhaps is the fact that imported skills do not permeate the economy to any great extent. There are two factors here: the need to compete in a fundamentally xenophile market, and the reluctance of foreign collaborators to import a complete technology. The second aspect has been dealt with; the first is best illustrated with reference to a concrete example: a well-known Indian firm which favour a more ‘nationalist’ line hand most had very nearly completed arrangements to manufacture ball- and roller bearings independently of outside help. Machinery had been copied and trials completed. A decision had been taken to start production (but to wait until the product was fully proved before marketing) when the news of the Tata-SKF projects Associated Bearing Co. Ltd.-broke. Knowinghow difficult it would be to compete against an internationally known brand, it felt com-pelled to enter into an agreement for technical collaboration with another foreign firm-solely to acquire the use of its trademark The point of the story is not simply that the Indian firm was forced into purchasing superfluous Tights; it lies more significantly in the fact that once imported, a technique is more likely to be duplicated within Indian industry through additional, competitive, and costly purchases abroad than through dissemination by the original importer. Government.. The Government is not blameless in this. It has shown great latitude in allowing investments in low priority spheres, or even banned ones, on receipt of promises to export a proportion of the product or to bring in a quantity of foreign exchange. As was admitted during a review of collaboration agreements in 1963, ‘the zest for licensing industries and for promoting collaborative ventures has at times resulted in a certain negligence in weighing the 1 Crested with NP nitro” profe the free tal online at iteconomic costs’. Its insistence on collaboration with foreign capital as a normal precondition for obtaining an industrial licence; its tolerance of restrictive provisions in the transfer of know-how; and its policy of encouraging, ostensibly in the interest of industrial democracy and regional development. a number of competing units where one or two will do. have done much to endorse it. The first two have been dealt with.! To illustrate the last, it is enough to mention that the Third Plan production targets of 60,000 trucks and 50,000 scooters are distributed between four units in the first case and seven in the second, each with its foreign collaborator and each ‘committed to substantial payments (in foreign exchange) on imported capital and technology. Since high cost small units ultimately determine prices, over-licensing on these lines adds to the large firms’ profits and to their remittances abroad, and so enhances the real value of their investment locally. Nor is the Government blameless for the other forms of excess imports. Its own plants are normally very capital-intensive through-out and impose a comparable structure on private units in shared industries. Its preparedness to pay high fees seems unlimited.4 And it is notorious for inviting foreign experts when equally or more suitable local ones are available. In fertilizer plant production, for example, the excess foreign exchange costs incurred on equipment specified by foreign consultants has been estimated at Rs 500 per ton on nitrogen, i.e., 20 per cent of the total cost, and might well turn out to be more, say Rs 800-900 per ton-altogether some Rs 10 crores a year in foreign exchange. At the same time a proven local design team has been disbanded. Ii In the case of state coal mines, the Limitation of IRR Method ‘The intemal rate of return (IRR) is a capital budgeting metric used by firms to decide whether they should make investments. It is an indicator of the efficiency or quality of an investment, as opposed to net present value (NPV), which indicates value or magnitude. ‘The IRR is the annualized effective compounded return rate which can be eared on the invested capital, i.e., the yield on the investment. Put another way, the internal rate of retum for an investment is the discount rate that makes the net present value of the investment's income ‘stream total to zero. A project is a good investment proposition if its IRR is greater than the rate of return that could be earned by alternate investments of equal risk (investing in other projects, buying bonds, even putting the money in a bank account). Thus, the IRR should be compared to any altemate costs of capital including an appropriate risk premium, In general, if the IRR is greater than the project's cost of capital, or hurdle vate, the project will add valué for the company. In the context of savings and loans the IRR is also called effective interest rate. 78 re NW nitro™ professiona download te fre trl online tit enon id withConservative Forecast The existing practice under which the entire work relating to a project, including the Preparation of project reports, working drawings. designs, etc. is dane hy the foreign collaborators, even though the [National Coal Development Corporation has the necessary technical know how to do it, has many drawbacks. In the case of steel plant design and construction, the Indian con-sultants originally assigned the fourth public plant at Bokaro had a constant battle to defend their appointment in face of the familiar argument that foreign credits were more or less conditional on foreign design and consultancy. In other cases foreign consultancy contracts have had to be prematurely terminated; with the French ACL (Ateliers et Chantiers de la Loire) after an Inquiry Committee had held it responsible for defects in ships constructed at Hindustan Shipyards; with the Swiss Oerlikon, technical consultants at Hindustan Machine Tools, where it was found that ‘so long as the factory was managed by foreign experts, it did not do anything good. But since the foreigners went away and some of our competent men took charge it is making amazing progress’ and with many others. The Cost of Servicing Quantities. Foreign private investment is expensive. At the very least profits run at 10 per cont per year after payment of taxes; 4 in all. A taste of the struggle, the first phase of which lasted until the United States withdrew from the project in the autumn of 1963, can be savored from the following report: “The Bokaro contract with M. N. Dastur and Co. Lid., Con-sulting Engineers, was finalized last August; but just before Dastur left for [the] United States, the Secretary of the Steel Ministry asked him to extend his stay in New Delhi by ‘two days for completing the signing of the agreement. Dastur waited but some last minute technicality came in the way and the contract was not “formally” signed. This is purely a matter of formality for in all Government documents, Dastur and Co. are still being referred to officially as the Consultants of Hindustan Steel on Bokaro, and they are continuing the preliminary work. This contract provides specifically that when aid has been negotiated, its terms may be varied- that is, the scope of the work to be done by M. N. Dastur and Co. may be altered-to suit the provisions of the aid agreement. But it has also been made gently known to the visiting AID negotiating team what the contract with the Indian firm of Consultants is, that it was still unsigned and. a hint has also been dropped that it will not stand in their way if the Americans do not want it. (NEW, 24 March 1962, p. 493.) Ironically, Teplacement of United States aid by Russian in 1964 has made M. N. Dastur and Co's future as consultants no more secure, since the Russians readily accepted official Indian suggestions that they build Bokaro on a ‘turn-key’ basis. The suggestions themselves appear to fit into a long-term drift towards building future steel plants in the private sector, or, if in the public sector, as ‘turn-key’ projects by Westem- Crested with f nitro” prof cd the free tral ontlargely American-companies. ‘Dasturism’ v. ‘tumkeyism’, still very much in the balance as late as February 1965, is signi-ficant to the future of more in India than steel. Probability they are very much more. To this should be added the high cost of knowhow, licences, and such-like. By comparison, the average rate of between 2 and 3 per cent charged on foreign public capital, including grants, seems modest. b. Kttect on the balance ot payments. Foreign investments are ex-pensive in another sense too. In theory, all profits are payable in foreign currency, unlike interest payments on public loans, half of which are made in rupees. The same distinction holds with regard to the repatriation of capital or the amortization of principal. In practice, of course, not all profits are distributed abroad year by year, nor has private capital been repatriated, net, over any length of time. None the less, servicing the two forms of capital flow has put very different strains on India’s foreign currency resources, strains out of all proportion to the volume of funds received. Inflexible foreign exchange cost.. Three characteristics of the payments on private account will be noticed from the Table, p. 308. First, the instability of capital repatriations, due almost entirely to the behaviour of oil investments, as comparison with Table 20, p. 309, will show. Second, the rapid growth in payments for royalties, fees, etc., reflecting the increase in technologically-intensive manufacturing investments and, to an unknown extent, book-keeping transfers into this category. Finally, the relative stability of profits distributed abroad-about Rs 26 ‘crores a year. This last might seem unremark-able; however, if payments are compared with profits eamed it becomes apparent that distribution abroad is normally the first charge on profits after tax, and retained earnings are more or less residual subject to most of the fluctuations in over-all ‘earnings. Plantations are noteworthy in this respect, but they are not alone. Comparison of Tables 17 and 20 shows that in petroleum in two out of the five years for which figures are available- 1958 and 1959-retentions out of profits were substantially higher than net invest-ments, the difference presumably going towards retiring the com-panies’ loans from their head offices abroad. In this way, some of the amount which appears as retained profits in Table 20 and repatriation of capital in Table 19 is no different in fact from the rest of profits distributed abroad. Figures for manufacturing are less explicit; Rs 1,396 crores of the Rs 2,666 crores of loans authorized during the first two Plans were repayable in rupees. About one third of the remainder-loans from the Easter Bloc-are in practice rupee loans, although not listed as such by the Reserve Bank. Tea-planting companies have long been known for their solicitude for share-holders: an analysis of balance sheets for 1939-53 shows that retained profits were inadequate to ensure even the maintenance of fixed capital over the period (Report of the Plantation Enquiry Commission, 1956, Part I, pp. 50, 57, 262). Besides, its raped growth in importance within the foreign sector lends credence to the view that some tow-thirds of all real profit retentions should be attributed to it. Nonetheless, as, 80 Crested with P nitro” prof cd the free talTablel9 suggests, the methods used by plantation and oil companies to transmute profit into capital and distribution into repatriation are open to many international firms and have been used by them. 4, Paucity of foreign exchange receipts: While current payments on private account are both growing and relatively inflexible, foreign investments offer little compensation in the way of foreign exchange receipts. Conforming to the almost universal reluctance to place risk capital in India, foreign operations are starved of convertible currencies: Black-Clawson, an American firm, is reported to have set up a Rs 2.5 crore plant without having added one dollar to India’s reserves by using rupee resources for machinery made locally or in. East European countries a Japanese consortium is said to have contributed their half of Hindustan-Kokoku Wire’s Rs 2 crores capital out of ‘retumed Japanese assets in India’. Needless to say, both suffer no abridgement in their right to receive earnings and repatriated capital in foreign currency at will. Not all investors are in a position to be as sparing in their use of foreign exchange, yet many run close behind. Given the manufacturing bias and technological intensity of new foreign investment, and the relative abundance of supporting capital, this is not a surprising attitude. It is, of course, immensely significant to India: during the fourteen years for which data exist, in which the foreign investment stake has more than doubled, foreign investors as a whole have taken out of the general currency reserve nearly three times as much as they contributed directly. Nor jis their indirect contribution through saving imports and adding to exports any better. On the contrary, the shifts from traditional export-eamers like tea and jute, to import-users like petroleum and manufacturing that can neither find export markets easily not are encouraged to do so by their foreign affiliates, has already turned the foreign sector's export surplus into deficit. Despite an increase in outstanding foreign business investments of Rs 325 crores between mid-1948 and the end of 1961, most of which might be attributed to manufacturing (including oil), the increase in new, manufactured exports has been small-from Rs 9 crores in 1950-1 to Rs 25 crores in 1959- 60; 2 and of this increase, as much as four-fifths perhaps-metal products, sewing-machines, electric fans -has been the product of purely Indian capital. At the same time, imports of raw and intermediate materials doubled during the decade. The point is best illustrated with reference to individual industries, rubber tyres, for example. Outlays on imported raw materials ranged between seven and seven and one-quarter crores of rupees a year between 1959-60 and 1961-2,3 to which should be added an annual remittance out of profits which are now considcrably more than the Rs 3.60 crores a year noted by the Tariff Commission in the early 1950’s.4 There is nothing to report on the other side of the industry's payments balance beyond token sales at, presumably, heavy discount, since the Indian ex-factory price of the basic tyre size for commercial vehicles is higher by an eighth than the intemational export price, calf. The Government is not unaware of the problem. Tariff Commission reports are studded with recommendations to have the restrictive export provisions 81 Crested with NP nitro™ professiona download te fre trl online titof many agreements revoked;6 the Government has repeatedly made clear its wish for free exports since the 1957-8 exchange crisis. More recently it has been ‘tying up, in many cases, new industrial undertakings coming up for industrial Establishment or Capital Goods licences, to an export performance’ But, as the Mudaliar Committee notes: ‘ “Promises” to export are sometimes lightly given by applicants seeking industriaVimport licences; or they may be accepted without detailed scrutiny of the real export potential and prospects of the projects in question or the applicants’ program in this behalf’s, In any case, there are limits to what the Government can do. The pull of the domestic market is strong; as well as being hampered by lack of knowledge, the Government lacks the resources to make exporting truly attractive; and foreign firms have the strongest possible incentives not to export. If necessary, they can-and do-replace formal agreements to limit exports with informal, but enforceable ones; sales networks abroad can be denied Indian products; and recalcitrant firms may rest assured in the knowledge that the Government will carry its feud with business or an individual firm well short of the point at which production would have to cease. No wonder that ‘quotas have remained conspicuously unfulfilled in industries without exposing the units concerned to any penalty’. ‘The Terms of Trade The effects of private capital imports go beyond the payments arithmetic outlined so far. ‘One aspect concems the terms of trade commodity imports into India tend to be highly priced. There are a number of factors here, only some of which can be influenced by India. An important one is the pricing policy of ‘actual user’ importers (who account for some 55 per cent of total imports) and their foreign associates.4 Not unrelated is the Government’s weak-ness vis-Clovis suppliers abroad.5 Together they form nearly one half of the terms of trade equation which moved steadily against India during the first two Plans. Concept of Project Appraisal It is frequently argued in support of private capital imports that they graft much needed managerial and technical skills onto Indian industry at little or no extra cost. The evidence, however, points the other way. Research and development are invariably conducted abroad; the fruits of development are imparted, if at all, at very high cost in royalties, fees, and other payments, and then not always in their entirety; through their production and staffing policies the ‘major investing firms attempt to systematize a continuing control of know show; and much else in the same vein.! Since the Indian partner is normally assigned-and readily accepts-a narrowly specialized range of functions, the diffusion of skills that does take place is largely fortuitous. Indeed, since the typical moder investing firm owes its dominance and income largely to its technological mono-poly, a different outcome would be surprising. 82 Crested with NW nitro™ professiona download te fre trl online tit fThe consequences are appreciable. Because skills are embodied in machinery as well as in men, technological dependence is a factor in the import dependence dealt with earlier. Together they help sustain the flow of excess capital imports in all its forms, adding to the burden of servicing payments (in foreign currency). In all these ways they are a factor in India's generally adverse terms of trade and, ultimately, in her deteriorating balance of payments. Payback period Probably the most portentous aspect of India’s technological dependence is the damping effect it has on the creation of new jobs. Foreign investments are themselves capital-intensive. In the com-petitive Indian milieu their effect is amplified through the adoption of similarly capital- intensive investment on the part of indigenous firms, mostly via further foreign collaboration. Since these invest-ments are to a great extent in the consumer goods industries, two contrary processes are set in motion: on the one hand, traditional producers, largely rural, are weakened, resulting in open payback period in some cases, but more generally in a further narrowing of the range of village occupations; hence in greater underemployment, greater downward pressure on rural wage rates; adding thus to the already massive body of factors preventing a rise in agricultural productivity. On the other hand, technologically intensive invest-ments in the modem industrial sector tend to push up skilled wage rates and so help generate a secondary round of pressures for capital intensive, labour-displacing investment. The resulting coincidence of relatively high wages for a small minority, increasing open un-employment in the towns, and unfulfilled expectations amongst the migrants from the country, constitutes a potentially explosive mixture. It would be too much to expect of Indian statistics to corroborate this sort of thesis in any detail. But the following facts seem relevant: the first two Plans created 12.5 million jobs directly or, assuming the Planning Commission's estimates for the Second Plan period to hold for both, just under 19 million directly and indireetly.1 The labour force increased by 47°5 million during the same period with the result that the backlog of unemployed, which planning was meant to eradicate, grew. ‘There is no estimate of job destruction for the period. Method Given a collection of pairs (time, cash flow) involved in a project, the internal rate of Tetum follows from the net present value as a function of the rate of return. A rate of return for which this function is zero is an internal rate of return. Thus, in the case of cash flows at whole numbers of years, to find the internal rate of Tetum, find the value(s) of r that satisfies the following equation: 83 Crested with NW nitro™ professiona download te fre trl online titNote that instead of converting to the present we can also convert to any other fixed time; the value obtained is zero if and only if the NPV is zero. In the case that the cash flows are random variables, such as in the case of a life annuity, the expected values are put into the formula, Calculate the internal rate of retum for an investment of 100 value in the first year followed by returns over the following 4 years, as shown below: Year | Cash Flow 0 =100 1 40, 2 59 3 55 4 20 Solution: ‘We use an iterative solver to determine the value of r that solves the following equation: ‘The result from the numerical iteration is . Graph of NPV as a function of r for the example This graph shows the changing of NPV in relation to r (labelled ‘i’ in the graph) Problems with using internal rate of return (IRR) As an investment decision tool, the calculated IRR should not be used to rate mutually exclusive projects, but only to decide whether a single project is worth investing in. NPV vs discount rate comparison for two mutually exclusive projects, Project 'A' has a higher NPV (for certain discount rates), even though its IRR (=x-axis intercept) is lower than for project 'B' (click to enlarge) In cases where one project has a higher initial investment than a second mutually exclusive project, the first project may have a lower IRR (expected return), but a higher NPV (increase in shareholders’ wealth) and should thus be accepted over the second project (assuming no capital constraints). IRR assumes reinvestment of positive cash flows during the project at the same calculated IRR. When positive cash flows cannot be reinvested back into the project, IRR 84 Crested with NW nitro™ professiona the free tal online at it foverstates returns. IRR is best used for projects with singular positive cash flows at the end of the project period. When the calculated IRR is higher than the truo reinvestment rate fur interim cash flows, the measure will overestimate — sometimes very significantly — the annual equivalent return from the project. The formula assumes that the company has additional projects, with equally attractive prospects, in which to invest the interim cash flows. This makes IRR a suitable (and popular) choice for analyzing venture capital and other private equity investments, as these strategies usually require several cash investments throughout the project, but only see one cash outflow at the end of the project (e.g. via IPO or M&A). Since IRR does not consider cost of capital, it should not be used to compare projects of sifferent duration. Modified Intemal Rate of Return (MIR) does consider cost of capital and provides a better indication of a project's efficiency in contributing to the firm's discounted cash flow. In the case of positive cash flows followed by negative ones (+ + - - -) the IRR is a rate for lending/owing money, so the lowest IRR is best. This applies for example when a customer makes a deposit before a specific machine is built. In a series of cash flows like (-10, 21, -11), one initially invests money, so a high rate of return is best, but then receives more than one possesses, so then one owes money, so now a low Tate of return is best. In this case it is not even clear whether a high or a low IRR is better. There may even be multiple IRRs for a single project, like in the example 0% as well as 10%. Examples of this type of project are strip mines and nuclear power plants, where there is usually a large cash outflow at the end of the project, In general, the IRR can be calculated by solving a polynomial equation. Sturm's theorem can be used to determine if that equation has a unique real solution, In general the IRR equation cannot be solved analytically but only iteratively. A potential shortcoming of the IRR method is that it does not take into account that the intermediate positive cash flows possibly come at inconvenient moments. Their reinvestment may have a lower yield. In that case it may be more realistic to compute the IRR of the project including the reinvestments until e.g. the end date of the project. Accordingly, MIRR is used, which has an assumed reinvestment rate, usually equal to the project's cost of capital. Despite a strong academic preference for NPV, surveys indicate that executives prefer IRR over NPV. Apparently, managers find it easier to compare investments of different sizes in terms of percentage rates of return than by dollars of NPV. However, NPV remains the "more 85 Crested with n nitro"; yro! cd the free tral ontaccurate" reflection of value to the business. IRR, as a measure of investment efficiency may give better insights in capital constrained situations. However, when comparing mutually exclusive projects, NPV is the appropriate measure. Planning “By almost any test’, wrote J. K. Galbraith midway during the second ‘big’ Plan, ‘the economy of India is less responsive to public guidance and direction than that of the United States. Indeed it is one of the world’s least controlled or “planned” economies’. In 1960-1, after a decade of planning, Government revenue at all levels and from all sources constituted about 11 per cent of national income (compared with about 41 per cent in Britain), and state plants accounted for 8.4 per cent of output from organized manufacturing industry. Nor is the picture changing at any speed, While the private sector has consistently over-fulfilled the targets set, public enterprise has lagged as consistently, with consequent changes in some very crucial ratios. Foreign investments contribute to the weakness of Indian plan-ning in a number of ways, two of which are important, No matter how large the Indian operations of foreign firmssometimes very large and very important indeed by Indian standards-these seldom form ‘more than a smail proportion of their global activities; on the other hand, no matter how small a firm's operations in the country they are part of a single fabric made up of the activities of Government and international agencies as well as private lending, investing, und trade organizations. While each firm might therefore find it relatively easy to withdraw when faced with what it considers an unacceptable demand on the part of the Government-as some indeed have done - India would have to pay a very heavy price for misjudging the threshold of acceptance common to the foreign sector as a whole, It is within this broad immunity that the price and profit adjustments, the erratic investment flows, the restraints on the diffusion of know-how, and the methods of control referred to in this and the preceding chapters flourish, Even more significant is the way in which foreign investments strengthen the private sector. Much of the dynamism of private industry can be traced directly to the increasing number of collaboration agreements concluded since 1957.3 These have provided knowhow, finance, foreign exchange, and moral support; they have been used to beat back taxation forays and to annex state projects for the private sector, they have drawn the teeth of the Government's threat to introduce foreign firms to break Indian monopolies. In a word, they have provided Indian industry with a toe-hold of extra-territoriality from which to confound the planners in every aspect of their work The distortions go deep. Denied resources, public sector projects are seldom completed on time; private sector demand for their services outruns the levels of supply envisaged in the original Plans, let alone the actual levels attained. Corruption attends the shortages and a lethal drain of materials and men takes place, the latter driven as much by the frustrations of working in 86 Created with @ nitro™ professiona download te fre trl online tit enonthe public sector as they are lured by the positive attractions of private industry. The state comes to depend more and more on foreign aid for its resources-to per cent of expenditure during the First Plan, 24 per cent during the Second, and a planned, but grossly underestimated, 29 per cent during the Third.! Pressure to permit private indusiry to break the bottlenecks becomes iesistible and with it the volume of foreign collaborations grows. Out of it all there evolves a foreign exchange fetishism some of whose illogic has to be seen to be believed. The growing dependence on foreign resources and, even more, the grow-ing resignation to such dependence, have affected the whole tenor of the Government's approach to foreign private capital: if in the first decade of Independence the official attitude was governed by con-siderations of control and economic power, it has since been pro-gressively determined by narrow balance-of-payments considerations with rather selfdefeating consequences in further concessions to the private sector, to foreign investors, further dependence on aid, further delays in public sector projects, and so on. Created with @ nitro™ professiona download te fre trl online tit f