FINANCIAL EVALUATION OF FINANCIAL EVALUATION OF R&D PROJECTSR&D PROJECTS

-Anusha R-Atiq Ahmed-Chandrashekar-Akshay-Aswin G Narayanan

Under the guidance of Prof. Venkatesh Ganapathy, Associate Professor.

RESEARCH & DEVELOPMENTRESEARCH & DEVELOPMENT Activities that a business chooses to conduct with the intention of

making a discovery that can either lead to the development of new products or procedures, or to improve the existing products or procedures.

Business – cost effective but more profitable.

TARGET COSTINGTARGET COSTING Target costing is a pricing method used by firms.

It is defined as "a cost management tool for reducing the overall cost of a product over its entire life-cycle with the help of production, engineering, research and design".

Japanese model – companies use target costing for new technology project development.

What does target cost planning system require? - > simple cost estimate for the product, broken down into components.

ELEMENTS OF LONG TERM FINANCIAL ELEMENTS OF LONG TERM FINANCIAL PLAN PLAN

Assumptions Ex : Interest rate, inflation rate, growth rate, exchange rate.

Sales forecast

Balance sheet & P&L A/C.

Indicates projected capital investments and working capital requirements overtime.

Sources of financing.

Cash Budget showing cash inflows & cash outflows.

METHODS OF EVALUATIONMETHODS OF EVALUATION

CAPITAL RATIONINGCAPITAL RATIONING Firm sets a fixed research and development budget (Previous Sales).

Projects are ranked to find out which projects can be funded..

Budgets – based on industry / Industrial benchmarks of firms performance.

PAY BACK METHODPAY BACK METHOD• A method of evaluating a project by measuring the time it will take to recover the initial investment.

T= Initial capital outlay / Annual cash flow

ROI MethodROI Method  Most common profitability ratio.ROI = Average Net Income after taxes / Average book

value of investment.

NPV MethodNPV MethodNPV = Present value of cash inflows – Present value of cash outflow

NPV = +ve, accept the project.

NPV = -ve, reject the project.

RISK ANALYSISRISK ANALYSISUncertainty of forecasted future cash flows streams .

statistical analysis to determine the probability of a project's success or failure, and possible future economic states.

Risk Analysis = Probability * Impact

Internal Rate of Return MethodInternal Rate of Return MethodI= C1/(1+K) +C2/(1+K)2 + C3/(1+K)3 + Cn/(I +

K)n

Where I = Initial investment in capital

C1, C2, C3, C4 ....... Cn = Cash returns at the end of the year 1, 2, 3 .... n

K= Internal rate of return (discount rate)

n = Life of the project.

IRR Method (Cont’d)IRR Method (Cont’d)In the IRR method, the present values of

cash outflows and inflows are equated and then rate of return is calculated.

OTHER MULTI CRITERIA METHODSOTHER MULTI CRITERIA METHODS

Decision maker considers a variety of criteria in establishing various investments in technology.

E.g. : Payback cost benefit, technological risk, business plan status.

ANALYTICAL HIERARCHY

Portfolio Grid ApproachPortfolio Grid Approach

Decision analytic techniques into decision processes and this framework extends to the portfolio decisions.

Decision quality determined at both the project level and the portfolio level, as well as in the interaction between these two levels

Data envelopment analysis: ( DEA)

-> It is a non parametric method in operations research and economics.

-> Used for the estimation of production frontiers to empirically measure 

productive efficiency of decision making units.

Non Parametric Method

A method commonly used in statistics to model and analyze ordinal or nominal data with small sample sizes. Unlike parametric models, nonparametric models do not require the modeler to make any assumptions about the distribution of the population, and so are sometimes referred to as a distribution-free method.

GROSS MARGIN RATIOGROSS MARGIN RATIO (Profits from new products introduced

during the year) --------------------------------------------------- The average fixed cost during the year in

R&D department

INNOVATION RATIOINNOVATION RATIO(The gross margin from new products introduced during the

year) / (The gross margin from all the products sold during the year)

SUMMARYSUMMARY R & D - Making a discovery that can either lead to the development/

improvement of a product.

Target Costing – reduces the overall cost of a product over its entire life-cycle.

Elements of long term financial plan.

Different methods of financial evaluation of R&D projects.

Trade-off between operational efficiency and effective delivery of R&D projects.