Project (Capital Budgeting)

and Production Management

By Prof. Ajay Ghangare
Unit 1
Overview to Project Management

• Easy to understand, not complicated

•It’s a complementary discipline that helps you
run your firm, business.
•Advantage : By PM, any one can be benefitted.
Project Definition : Idea , Design or Plan -----------
concrete activity

Like factory, movie, Building, Human Development, 5th sem

project, Hospital.

Production: Definition

Difference.
Projects Productions

Automobile factory Producing automobiles

Build a house Operate Household

Construct Hospital Treatment of patients

Making a movie Making many movies

Done only once Done Repetitively

•Projects and productions are Interwoven

•Because after project, Production starts.

To run any project we need to know about
two things :
1. Project Life Cycle.
2. Project Management process.
Project life cycle

1. Eg Human Development.

Birth -> Childhood -> adulthood -> old age ->

death

2. Eg IT project

High level design -> detailed design -> Coding ->

Testing -> Installation -> Turnover
Project Management Process

•We have to manage every process of project life cycle

•Birth – after birth, you have to do something to reach to

childhood
•Childhood – after childhood, you have to do something to
reach to adulthood…

So on ..
 Phases of Capital Budgeting ( Project)

Planning
Analysis (Feasibility ) Feedback
Selection Feedback
Financing Feedback
Implementation Feedback
Review Feedback
Planning

•Important
•No Detailed proposal
•Two Important things

1.To make project charter

2.To identify stakeholders (Sponsors)
Project Charger

Document outlining few things like

•Objectives ,
•Scope
•Rough Idea about cost and time
•Key stakeholders

STAKE HOLDERS

•Wife
•Neighbors
•Business entity
•Leader
2.Analysis (Feasibility study )

If the first stage of planning is proper, then

•Marketing Analysis
•Technical Analysis
•Financial Analysis
•Economic Analysis
•Ecological Analysis
 3. Selection of a project
Is project worth while ?

Worth whilness is judged by different parameters

•Payback period
•Accounting rate of return
•Net present value
•Internal Rate of return
•Benefit cost ratio
 4. Financing

•Equity
•Debt
•Venture capitalists
•Debentures
•Loans
 5.Implementation

Includes

•Project and engineering design

•Negotiation and contracting (passing tenders)
•Construction
•Training
•Plant Commissioning (commencement )
 6. Review

•Starts after commencement of a project.

•Regular performance reviews should be taken

•Feedbacks
 Facets of Project Analysis

•Market Analysis
•Technical Analysis
•Financial Analysis
•Economic Analysis
•Ecological Analysis
Market Analysis

Concerns with two questions

•Aggregate demand for the proposed product/project.

•Market share of the project. Reliance Jio, Patanjali.

To answer the above questions, following things are necessary to understand

•Consumption trends in the past and present

•Past and present supply position
•Production possibilities and constraints
•Imports and exports
•Structure of competition
•Consumer behavior
•Distribution channel.
Technical Analysis

Technical analysis and engineering aspects of a project needs

to be done continually when a project is formulated.
Nagpur Metro soil test.

•Checking of location, size, process etc.

•Preliminary tests
•Availability of raw material , power, etc
•Suitable production process
•Checking of merits and demerits , etc
•Selection of technology
•Machinery and equipment
•Primary and secondary sources.
Financial Analysis

To check financial viability

•Sources of finance
•Checking of debt repayment
•Equity options
•Investment
•Means of financing
•Cost of capital
•Projected profitability
•Break even point
•Level of risk ,etc
Economic Analysis

Also termed as social cost benefit analysis Judging project

from social point of view.

•Impact on society
•Employment generation
•Impact on GDP
•Impact on economy.
•Distribution of income(Jobs Creation)
 Ecological Analysis

•Environment concerns.
•Impact on ecology.
•Damage caused by the project to the environment.
•Cost of saving measures to control damage caused by
the project.
 Unit 2
Techniques of Evaluation of a Project
Non – DISCOUNTED Discounted cash flow
Cash Flow
Pay Back Period (PB) Net Present Value
(NPV)
Accounting Rate of Internal Rate of return
return (ARR) (ROI) (IRR)
Profitability Index
(Cost Benefit Ratio)
Discounted payback
period.
 Pay Back Period

•It is the most widely accepted method of evaluating

Investment proposals.
•It is the number of years required to recover the original
cash outlay invested
In a project.
•Usually expressed in years.
•This method specifies the recovery time.
•Number of years required to recover cost of investment.
•It is the first screening process.
•The project with less pay back period may be accepted
than the project with higher Pay back period.
Merits

•Simple and easy to calculate.

•The risk of the project can be handled by choosing the project with less pay
back period.
•It saves analysis time as it is very easy to calculate.
•The emphasis is given to reach break even point ASAP.

Demerits

•It does not indicate whether an investment should be accepted or rejected unless
the payback period is compared with some standard set by Management.

•It does not give you profitability figures.

•It does not take into account the whole life span of a project.

•It does not give you percentage returns.

Accounting Rate of Return (ARR)

•It also means the return on Investment (ROI) or return on Capital employed.

•The method uses to calculate the increase in profit expected to result from
An investment. ARR calculates the return, generated from net income of
the proposed capital investment. The ARR is a percentage return.

•The one with the highest rate of return is taken to be the best investment proposal .

•This method is superior to pay back method as it gives you profitability.

•It also takes into account the whole life of a project.

•Simple to understand and easy to use.

•It is not concerned with the cash inflows incurred in the project.

•It takes into account net profit earned for subsequent years.

•It does not indicate whether an investment should be accepted or not , unless the rate
Of return is compared with some standard set.
Accounting rate of return = Average Income / Average Investment
 Cash Inflow
Funds received by a company due to sales, financing, or investments . Cash inflows
are used to gauge the overall financial health of a business, and
a company with a large and stable cash inflow can be considered to
be in a good financial position.

Cash Outflow
Definition. The total outgoing funds from a company in a given period of time.

Present Value

It’s an indication of whether the money an investor receives today can

earn a return in the future. PV is widely used in finance in the stock valuation,
bond pricing, and financial modeling.
Profitability Index (PI)

•It is the present value of an anticipated future cash inflows divided by initial outlay.

•PI = Present value of cash inflows / present value of cash outlay.

•A project is accepted if its PI value is greater than 1.

•The project with higher PI would be chosen than the project with lower PI while
•comparing.
•It is a useful tool for ranking projects because it allows you to quantify the amount of
value created per unit of investment.

Merits
•tells about an investment increasing or decreasing the firm’s value
•It takes into account the time value of money.
•It is a relative measure of a project’s profitability.
•takes into consideration all cash flows of the project.

Limitations
•The profitability index of a firm might not, sometimes, provide the correct
decision while being used to compare mutually exclusive projects under consideration.
 
Net Present Value (NPV)

•Net present value (NPV) is the difference between the present value of cash
inflows and the present value of cash outflows (Initial Investment) over a
period of time.

•NPV is used in capital budgeting to analyze the profitability of a projected

investment or project. 

•A positive net present value indicates that the projected earnings generated
by a project or investment exceeds the anticipated costs.

•Generally, an investment with a positive NPV will be profitable, and an

investment with a negative NPV will result in a net loss. 
Drawbacks

•NPV is that NPV relies heavily upon multiple assumptions and estimates,
so there can be substantial room for error.

•A project may often require unforeseen expenditures to get off the ground
or may require additional expenditure at the project’s end.

Payback Period, or “payback method,” is one popular metric that is

frequently used as an alternative to net present value. It is much simpler
than NPV.
Internal Rate of Return (IRR)

•Formula is same as that of NPV .But here we have to calculate the value of
r assuming the value of NPV as zero.

•It is a percentage discount rate used in capital investment projects which

brings the initial investment (cost of project) and its future cash inflows
into equality.

•It is also defined as the rate at which Net Present Value is zero.

•It is calculated by trial and error method.

•It considers the time value of money.

•It takes into account total cash inflows and cash outflows.
Limitations

•It involves tedious calculations based on trial and error method.

•It produces multiple rates which can be confusing

•It may fail to indicate a correct choice between mutually exclusive projects under
Certain situations.