Project Mgt

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01/01/2010 1 PROJECT MANAGEMENT MMS, PGDM (Ops.) (2009- 11) - Semester IV.

Transcript of Project Mgt

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PROJECT MANAGEMENT

MMS, PGDM (Ops.) (2009-11)

- Semester IV.

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The things which I always want you to act on……but which you don’t:

• Read the portions in advance;

• Do not miss any class;

• Be attentive in the class;

• Seek clarifications when required;

• Read the topics dealt with in the class on the same day or discuss with your friends to enhance your understanding of the topic;

• Quickly revise all the covered portions at least once in a week.

• If you do all the above, ‘My Good Wishes are Always with All of You’ will definitely work.01/01/2010 2

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Index to Topics:No Name of Topic Slide

Nos.:1. Introduction, Scope and coverage 11 - 62

2. Project Function in an organisation, Layout of Project Department, Role of Consultants in Project Management

63 -107

3. Project Identification – Selection of product, identification of market, preparation of feasibility study/report

110 - 147

4. Project formulation, Evaluation of risks, preparation of project report.

148 – 183

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5 Selection of location and site of the project, Factors affecting location

184 – 219

6 Policies of Central and State Governments towards location, Legal aspects of Project management

220 – 334

7 Financial analysis-Profitability Analysis, Social Cost Benefit Analysis

335 – 423

8 Budget and Cash Flows 424 -

9 Materials Management in Project Planning-Procurement, storage and disposal

10 Financing of the project –Sources of Finance, Cost implications thereof

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11

Financial Institutions- Guidelines for funding projects, Risk Analysis – Sensitivity Analysis

12

Quantitative aspects of projects – PERT/CPM, Network analysis for monitoring of the project

13

Computer applications – Selection of software packages for application to Project Management

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Reference Books

1. SC : Project Management – By S.Chaudhury;

2. PG : Text Book of Project Management –

By P.Gopalakrishnan and V E Ramamoorthy;

3. PC: Project Management – By Prasanna Chandra (SeventhEdition, 2009/Sixth Edition); (Tata McGraw –Hill Publishing Co. Ltd)

• 4. PM: Project Appraisal – By P K Mattoo;• 5. VD : Project Management – By Vasant Desai

(3rd revised Edition, 2008)- (Himalaya Publishing House);

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Reference Books…

• 6. IC: Project Management by ICFAI Centre for Management Research;

• 7. ICFAI : Finance Series- Project Management: Vol. I to V by ICFAI;

• 8.Project Management – The Managerial Process : By Clifford F. Gray and Eric W. Larson-3rd Edition –Tata McGraw Hill Education Pvt. Ltd.

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Useful Websites• http://www.dipp.nic.in (Dept. Of Industrial Policy and

Promotion, Govt. of India);• http://www.india.gov.in (Government of India);• http://www.rbi.org.in (Reserve Bank of India;• www.ifciltd.com (Industrial Finance Corporation of India

Ltd.);• http://www.weforum.org (World Economic Forum,

Geneva, Switzerland• (www.icicibank.com (ICICI Bank Ltd.);• www.idbi.com (IDBI Bank Ltd.);• www.utimf.com (UTI Mutual Funds); • www.utiventures.com (UTI Ventures Ltd.);01/01/2010 8

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Useful Websites....

• www.licindia.com (Life Insurance Corporation of India);• www.nsic.co.in (National Small Industries Corporation

Ltd.) • www.sidbi.com (Small Industries Development Bank of

India Ltd.); • http://www.idfcpe.com/pages/main1.html and

http://www.idfc.com ) (Infrastructure Development Finance Co. Ltd.-IDFC);

• www.eximbankindia.com (Export-Import Bank of India);

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Useful Websites....

• www.nabard.org (National Agricultural Bank for Rural Development-NABARD);

• http://www.worldbank.org/ (World Bank):• http://www.microsoft.com/project/en/us/product-informatio

n.aspx (Microsoft Office Project Professional –Project Soft ware) ---------------------------------------------------------------------------

Total Marks: 100 (Internal Assessment: 40 marks + Final Written Examination : 60 marks)

(Internal Assessment : Attendance : 10 marks + Presentations - Assignments of Teaching of topics to the class : 15 marks + Class Test : 15 marks. )

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1. Introduction: Project and Project Management

• “Project Management is the business process of creating a unique product, service or result. A project is a finite endeavour having specific start and completion dates undertaken to create a quantifiable deliverable. Projects undergo progressive elaboration by developing in steps and predictable increments that are tied to benchmarks, milestones and completion dates.”

• A Project is a specific activity on which money is spent in the expectation of returns. There is therefore a specific starting point, a specific end point and it is intended to achieve a specific objective.

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1.Introduction: Project and Project Management

• Project is an organised programme of activity carried out to reach a defined goal, often of a non-recurring nature with a specified terminal point.

• It is a package of time-bound, scheduled and assembled activities dedicated to the attainment of a specific objective of successful completion of a work on time and within the allotted budget.

• Project is a one-shot, time-tested, goal-directed major undertaking requiring the commitment of varied skills and resources.

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1.Introduction: Project and Project Management

• Project is the whole complex of activities involved in using resources to gain benefits.

• Project is a system involving coordination of a number of interrelated activities to achieve a specific objective.

• Project Management Institute (PMI) : “A Project is a temporary endeavour undertaken to create a unique product or service.” “Project Management is the application of knowledge , skills, tools and techniques to project activities in order to meet or exceed stakeholder needs and expectations.”

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1.Introduction: Project and Project Management

• The British Standard (1996) : “Project is a unique set of coordinated activities, with definite starting and finishing points, undertaken by an individual or organisation to meet specific objectives within defined schedule, cost and performance parameters.”

• Some examples of ‘projects’ are: relocating a factory, constructing national highways, organising the Olympics and constructing a hydro power generating facility.

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What is not a project?

• Emergency response to operations problems– Callouts– Repairs and troubleshooting

• Routine operations support– Maintenance of equipment– Minor modifications and tuning of equipment

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1.Introduction: Project and Project Management

• This finite characteristic of projects stands in sharp contrast to processes, or operations, which are permanent or semi-permanent functional work to repetitively produce the same product or service.

• In practice, the management of these two systems is often found to be quite different, and as such requires the development of distinct technical skills and the adoption of a separate management philosophy.

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1.Introduction: Project and Project Management

• Project Management (PM) is quite unique. It calls for sharper tools of planning and control and improved ways of coping with human problems caused in a project setting.

• PM is complex. It involves issues like forms of project organisation, project planning, project control and human aspects of PM.

• PM is always customer specific, the requirements and constraints within which a project must be executed are stipulated by the customer.

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1.Introduction: Project and Project Management

• PM is always interdependent and inter-related. The management should be quick and flexible in dealing with ever-changing dynamic situations which pervade very many aspects of the society.

• In sum, PM is a teamwork. It will organise around a process that is essentially customer-oriented. It will always strive to bring maximum benefit to the society with minimum cost within the shortest stipulated time frame.

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1.Introduction: Project and Project Management

• Generally, Organisational structures and processes are custom made to produce a specific product or service. Sometimes, organisations have to take up new tasks that they are not equipped to handle.

• These tasks are new to the organisation as they are not performed earlier or they may not be repeated in the future.

• To perform such unique tasks, organisations adopt the project approach. The project approach is adopted when the existing systems in the parent organisation are not equipped to handle the new task.

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1.Introduction: Project and Project Management

• Some of the characteristics of the tasks that qualify to be projects are:Unique activities; Attainment of a specific goal;Sequence of activities; Specified time; Interrelated activities.

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Project Management - Knowledge Areas:

• Scope Management• Time Management• Cost Management• Quality Management

• Human Resources Management (Organizational Planning; Staff Acquisition; Team Development )

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Knowledge Areas….

• Communications Management (Communications Planning; Information Distribution; Performance Reporting; Administrative Closure )

• Risk Management (Risk Identification; Risk Quantification; Risk Response Development; Risk Response Control)

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Knowledge Areas….

• Procurement Management (Procurement Planning; Solicitation Planning; Solicitation; Source Selection; Contract Administration; Contract Close-out)

• Integration Management ( Project Plan Development; Project Plan Execution

Overall Change Control )

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Leadership Skills:• Vision and Strategy

• Establishing Direction

• Aligning People

• Communicating

• Negotiating

• Motivating and Inspiring

• Influencing Organizations

• Overcoming Barriers to Change

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General Management Skills:• Planning• Finance and Accounting• Personnel Administration• Technology• Organizational Development• Delegation• Team Building• Conflict Management• Solving Problems

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Communications Skills:

• Writing

• Listening

• Speaking

• Presenting

• Media Relations

• Meeting Management

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Project Management

• The success of a project depends on the project manager’s ability to strike a balance between these interrelated variables or constraints. Some of the common constraints that influence the project are:

Scope; Quality; Cost; Time; Resources.

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1.Introduction: Scope and coverage

• ‘Scope’ of a project: • A project management term for the combined

objectives and requirements necessary to complete a project.

• Properly defining the scope of a project allows a manager to estimate costs and the time required to finish the project.

• Scope can involve a variety of things, depending on the type of project. For example, if the project was to design an airplane, the scope could include the functional requirements of the plane, such as how many passengers it can carry or how fast it should be able to travel.

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1.Introduction: Scope and coverage

• It is the responsibility of the project manager to ensure that the scope's deadlines are met, allowing for smooth completion of the project.

• This may be sidetracked by scope creep, which occurs when the project gains additional features or requirements without extending the deadline.

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1.Introduction: Scope and coverage

• The Scope of a project can be divided into two parts: ‘Product Scope’ and ‘Project Scope’.

• The Product Scope details all the functions and features that are to be included in a product or service of a product whereas the Project Scope details the work to be done to deliver a required product with specific features.

• The tools and techniques for managing product scope vary with the nature of the project.

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Scope Management:

• Initiation

• Scope Planning

• Scope Definition

• Scope Verification

• Scope Change Control

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Scope Management:

• Project Planning : Components:

What ? : Work Breakdown Structure;

How? : Plans and Specifications;

Who? : Organisation Breakdown Structure;

How Much?: Cost Breakdown Structure (Via Estimates);

When? : Schedule.

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1.Introduction: Scope and coverage

• In PM, the scope of a project is the sum total of all of its products and their requirements or features. Sometimes the term scope is used to mean the totality of work needed to complete a project.

• Scope is a brief and accurate description of the end-products or deliverables to be expected from the project that meet the requirements.

• Scope describes all the activities that are to be performed, resources that will be consumed and the end-products from the successful completion of the project, including quality standards.

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1.Introduction: Scope Statement

• The scope also includes the target outcomes, prospective customers, outputs, work, financial and human resources required to complete the project.

• Scope Planning/Statement: Scope Planning involves the development of the Scope Statement.

• The Project Manager uses tools like product analysis, cost/benefit analysis, and expert judgment to develop the scope of a project.

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1.Introduction: Scope Statement

• In traditional PM, the tools to describe a project's scope (product) are the product breakdown structure and product descriptions.

• The primary tool to describe a project's scope (work) is the work breakdown structure.

• Scope statements may take many forms depending on the type of project being implemented and the nature of the organization.

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1.Introduction: Scope Statement • The scope statement details the project

deliverables and describes the major objectives. The objectives should include measurable success criteria for the project.

• ‘Deliverables’ is a Project Management term for the quantifiable goods or services that will be provided upon the completion of a project.

• Deliverables can be tangible or intangible parts of the development process, and are often specified functions or characteristics of the project.

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1.Introduction: Scope Statement

• As a baseline, scope statements should contain:The project name The project charter

(A project charter or project definition --sometimes called the terms of reference-- is a statement of the scope, objectives and participants in a project. It provides a preliminary delineation of roles and responsibilities,……

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1.Introduction: Scope Statement

….outlines the project objectives, identifies the main stakeholders, and defines the authority of the project manager. It serves as a reference of authority for the future of the project.)

The project owner, sponsors, and stakeholders

The problem statement The project goals and objectives

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1.Introduction: Scope Statement-Product Breakdown Structure (PBS)

The project requirements The project deliverables The project non-goals (what is out of scope) Milestones Cost estimates

• In PM, a product breakdown structure (PBS) is an exhaustive, hierarchical tree structure of components that make up an item, arranged in whole-part relationship.

• A PBS can help clarify what is to be delivered by the project and can help build a Work Breakdown Structure (WBS).

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1.Introduction: Scope Statement-PBS • The PRINCE2 project management method

mandates the use of product based planning, part of which is developing a product breakdown structure.

• PRojects IN Controlled Environments (PRINCE) is a project management method. It covers the management, control and organisation of a project. "PRINCE2" refers to the second major version of this method and is a registered trademark of the Office of Government Commerce (OGC), an independent office of HM Treasury of the United Kingdom.

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PRINCE2• PRINCE2 is a structured approach to project

management. • It provides a method for managing projects within a

clearly defined framework. • PRINCE2 describes procedures to coordinate

people and activities in a project, how to design and supervise the project, and what to do if the project has to be adjusted if it doesn’t develop as planned.

• In the method each process is specified with its key inputs and outputs and with specific goals and activities to be carried out, which gives an automatic control of any deviations from the plan.

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1.Introduction: Scope Statement-PBS

• Example : PBS of a computer:Main unit : -Housing; --Motherboard : CPU,

• RAM chips, ... ; -- FDD, --HDD, --Video card,--Sound card, --Network card, --LPT port card.

Monitor : --CRT, --Housing, --Electronic components

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1.Introduction: Scope Statement-Work Breakdown Structure (WBS)

Mouse : --Body, --Marble, --Cable….. Keyboard

• A WBS in project management and systems engineering, is a tool that defines a project and groups the project’s discrete work elements in a way that helps organize and define the total work scope of the project.

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1.Introduction: Scope Statement-WBS

• A WBS element may be a product, data, a service, or any combination. WBS also provides the necessary framework for detailed cost estimating and control along with providing guidance for schedule development and control.

• Additionally the WBS is a dynamic tool and can be revised and updated as needed by the project manager.

• The WBS is a tree structure, which shows a subdivision of effort required to achieve an objective; for example a program, project, and contract.

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1.Introduction: Scope Statement-WBS

• The WBS may show hardware, product, service, or may be process oriented. In a project of contract, the WBS is developed by starting with :– the end objective and – successively subdividing it into manageable

components – in terms of size, duration, and responsibility

(e.g., systems, subsystems, components, tasks, subtasks, and work packages)

– which include all steps necessary to achieve the objective.

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1.Introduction: Scope Statement-WBS

• The WBS provides a common framework for the natural development of the overall planning and control of a contract and is the basis for dividing work into definable increments from which the statement of work can be developed and technical, schedule, cost, and labour hour reporting can be established.

• A WBS permits summing of subordinate costs for tasks, materials, etc., into their successively higher level “parent” tasks, materials, etc.

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1.Introduction: Scope Statement-WBS

• For each element of the WBS, a description of the task to be performed is generated.

• This technique (sometimes called a System Breakdown Structure) is used to define and organize the total scope of a project.

• A WBS is not an exhaustive list of work. It is instead a comprehensive classification of project scope.

• A WBS is not a project plan or a project schedule and it is not a chronological listing.

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1.Introduction: Scope Statement-WBS

• It is considered poor practice to construct a project schedule (e.g. using project management software) before designing a proper WBS.

• This would be similar to scheduling the activities of home construction before completing the house design.

• Without concentrating on planned outcomes, it is very difficult to follow the 100% Rule at all levels of the WBS hierarchy. (See the 100% rule elaborated in the notes).

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1.Introduction: Scope Statement-WBS

• If the WBS designer attempts to capture any action-oriented details in the WBS, he/she will likely include either too many actions or too few actions.

• Too many actions will exceed 100% of the parent's scope and too few will fall short of 100% of the parent's scope.

• The best way to adhere to the 100% Rule is to define WBS elements in terms of outcomes or results.

• This also ensures that the WBS is not overly prescriptive of methods.

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1.Introduction: Scope Statement-WBS

• Mutually exclusive elements : In addition to the 100% Rule, it is important that there is no overlap in scope definition between two elements of a WBS.

• This ambiguity could result in duplicated work or miscommunications about responsibility and authority.

• Likewise, such overlap is likely to cause confusion regarding project cost accounting.

• A WBS is not an organizational hierarchy.

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1.Introduction: Scope Statement-WBS

• Some practitioners make the mistake of creating a WBS that shadows the organizational chart.

• While it is common for responsibility to be assigned to organizational elements, a WBS that shadows the organizational structure is not descriptive of the project scope and is not outcome-oriented.

• WBS updates, other than progressive elaboration of details, require formal change control. This is another reason why a WBS should be outcome-oriented and not be prescriptive of methods.

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1.Introduction: Scope Management Plan

• Methods can, and do change frequently, but changes in planned outcomes require a higher degree of formality.

• If outcomes and actions are blended, change control may be too rigid for actions and too informal for outcomes.

• A WBS is not a logic model. Nor is it a strategy map.

• Scope Management Plan is one of the major Scope communication documents.

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1.Introduction: Scope Management Plan

• The Project Scope Management Plan documents how the project scope will be defined, managed, controlled, verified and communicated to the project team and stakeholders/customers.

• It also includes all work required to complete the project.

• The documents are used to control what is in and out of the scope of the project.

• The Project Scope Management plan is included in as one of the sections in the overall Project Management plan.

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1.Introduction: Scope Management Plan • It can be very detailed and formal or loosely framed

and informal, depending on the communication needs of the project.

• Product Analysis is a technique for understanding the features and functions of a product.

• Techniques like ‘Value Analysis’ and ‘Quality Function Deployment’ help the Project Manager gain more information regarding the project.

• By enhancing the level of his knowledge of the project’s product, the project manager can define the scope of the project more precisely.

{Value engineering (VE) is a systematic method to improve the "value" of goods and services by using an examination of function. ……..

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1.Introduction: Scope Management Plan …….Value engineering is also referred to as

"value management" or "value methodology" (VM), and "value analysis" (VA)}

{Quality function deployment (QFD) is a “method to transform user demands into design quality, to deploy the functions forming quality, and to deploy methods for achieving the design quality into subsystems and component parts, and ultimately to specific elements of the manufacturing process.”- as described by Dr. Yoji Akao, who originally developed QFD in Japan in 1966, when the author combined his work in quality assurance and quality control points with function deployment used in Value Engineering.}

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1.Introduction: Project phases

• QFD is designed to help planners focus on characteristics of a new or existing product or service from the viewpoints of market segments, company, or technology-development needs. The technique yields graphs and matrices.

• QFD helps transform customer needs (the voice of the customer [VOC]) into engineering characteristics (and appropriate test methods) for a product or service, prioritizing each product or service characteristic while simultaneously setting development targets for product or service. (See more in notes from Wikipedia)

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Project phases

• PM can be divided into six phases:• Initiation phase, 2.Definition phase, 3.Design

phase, 4.Development phase, 5.Implementation phase and 6.Follow-up phase.

• You may also look at the project activities as Pre-project and post-project and break them into several stages for a clear understanding of the tasks involved in a project.

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1.Introduction: Project phases

• Pre-project activities may be generally broken down as:

Conceptualising Market Survey, feasibility study and expansion plans giving final picture Focussing with respect to quality, capacity or product mix with capacities Site selection, taking into consideration availability of raw materials, infrastructural facilities, finished goods, market location or area targeted, and a balance amongst these Basic engineering and extended basic engineering considering local condition…..

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1.Introduction: Project phases

…..Detailed engineering and statutory documentation preparation for required approvals from various bodies, safety and security Procurement, transportation and insurance etc. erection and pre-commissioning activities Commissioning Performance trials and commercial production.

• The Post-project activities may be similarly broken down into the following activities:

Stabilising the process parameters and instrument settings…..

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1.Introduction: Project phases

….Preparation of ‘as–built’ drawings, incorporating all the changes/ modifications made during execution, commissioning and stabilising operations including field changes, and all the operating disciplines Training of operation, maintenance and safety staff Compilation of all operating and maintenance manuals, catalogues, drawings and technical details, in an easily retrievable manner including guarantees for equipments Awareness programmes for quality and safety Monitoring balance erection work such as roads, drains, plastering, paintings etc.,….

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1.Introduction: Project phases

…. Finalising contractors’ bills and sorting out disputes with suppliers and contractors Site-cleaning and housekeeping Storage of spares with proper inventory and security.

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2. Organising Project Dept.

Organisational planning of Project Dept.: An organisation can be defined as a group of

individuals who coordinate their activities in order to accomplish a business and /or social objective.

Organisational planning is a process of identifying, documenting, and assigning project roles, responsibilities, and reporting relationships.

Choosing an appropriate organisational structure facilitates the effective implementation of an organisational plan.

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2. Organising Project Dept.

• The individuals or groups who may be a part of the organisation or may be external to it.

• The structure of an organisation is dependent on parameters like the rate of change of technology, availability of resources, the product/services sold, competition and other decision making requirements.

• Developing an organisational structure also helps in delegating tasks with responsibility and accountability.

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2. Organising Project Dept.

• A project manager’s choice of organisational structure depends on the nature of the project and the degree of control required for its implementation.

• Some of the organisational structures that a project manager can consider are:

Traditional Organisational Structure Pure PRODUCT Organisational Structure Pure PROJECT Organisational Structure Matrix Organisational Structure.

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2. Organising Project Dept.

• The Traditional Organisational Structure is developed around the functional aspects of the organisation such as engineering, manufacturing, marketing, human resource and information systems.

• While Projects in individual functional departments do not face any problems, when different departments have to be coordinated, the project manager may have to assign, control and monitor the work through the functional manager, because of his lack of authority in the functional department.

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2. Organising Project Dept.

• Some of the advantages and disadvantages of the Traditional structure are as follows

Advantages Disadvantages

Easy control,

budgeting procedures

No single person is responsible for the total project – lack of authority and hence reduced motivation and innovation

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Sharing of knowledge and

responsibility and grouping of specialists

Project-oriented emphasis is absent and hence lacks customer focus and slow in responding to customers’ needs, ideas are function oriented and not project-oriented—difficulty in achieving tasks

Flexibility in use of broad

manpower

Complex coordinating system—consumes more time in approving the decisions

Continuity in functional

disciplines

Possibility of partiality in decision making

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Reporting structure with good control over

people

Lack of proper project-oriented planning and authority-leads to difficulty in pinpointing responsibilities.

Quick reactions to situations depending

upon the functional manager’s priority.

2. Organising Project Dept.

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2. Organising Project Dept.

• Pure Product Organisational Structure is developed on the basis of managing individual products as functional departments. Each individual product is assigned a product manager who has functional specialists to assist him.

• The basic advantage of this structure is the individual line of authority, i.e. a single individual has the authority to control the entire activity.

• Its narrow reporting structure helps develop a strong communication channel along with accelerated feedback.

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Advantages Disadvantages

Enables strong control because of

single project authority

Duplication of efforts, facilities and personnel – leading to prohibitive costs of maintenance in multi-product organisations

Direct link between the project manager

and other stakeholders

Retains personnel in projects longer than necessary

2. Organising Project Dept.

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Develops strong communication

channels

Firm’s progress is hindered by the lack of strong functional groups and technology

Maintains project expertise without

sharing key personnel

Controlling functional specialists requires top level coordination

Facilitates speedy reactions to

situations

Technology is not shared among projects

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Facilitates loyalty of team members towards project

No career prospects for the project team

Retains attention on customer relations

Enhances decision making efficiency of senior

management

2. Organising Project Dept.

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2. Organising Project Dept.• Pure Project Organisational Structure:

Organisations working on large and long-term projects usually adopt pure project organisational structure.

• This type of organisation structure contains functional departments within the individual projects.

• All the team members contribute on full time basis.

• This is a vertical organisational structure which avoids conflicts and problems faced by the traditional and product organisational structures.

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Advantages DisadvantagesThe Project Manager has complete

authority over the projectInefficiency in resource utilisation

The Project Manager has the freedom to acquire the resources needed for the project’s progress

Duplication of facilities

The Project team reports directly to the Project Manager – thus

develops a formal communication channel between the Project

Manager and his team

Sourcing personnel from internal functional departments to work on the project affects work in the functional departments

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2. Organising Project Dept.

The Project personnel are shared between the project and the project organisation

Facilitates unity of command

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2. Organising Project Dept.

The Matrix Organisational Structure: A Matrix organisational structure is formed as a result of combining the advantages of all the aforementioned organisational structures.

• It is suitable for project driven organisations like software development firms.

• It makes the Project Manager totally responsible and accountable for the success for a project.

• Every project is treated as profit centre. Hence the GM directly assigns power and authority to the Project Manager to handle the project……

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2. Organising Project Dept.

• …….The Project Manager is responsible for the technical excellence of the functional departments in managing the departments.

• This structure functions in a collaborative manner – i.e. it shares the information and personnel while executing the project.

• The primary objective of the Matrix organisational structure is to derive synergy through shared responsibility between the project and functional management.

• The strength of the structure depends on the level of control that the Project Manager is able to exercise over the functional resources.

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2. Organising Project Dept.

• Advantages of the Matrix organisational structure:

Enables the Project Manager to exercise control over all the resources

Every project has its own independent set of policies and procedures

Authorises the Project Manager to commit the company resources ensuring that scheduling does not clash with other projects

Facilitates quick response to conflicts, changes and other project needs

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2. Organising Project Dept.

Derives support of the functional department to the project

Enables proper HR Development by enhancing the career prospects of team members

Facilitates cost minimisation by sharing key personnel

Facilitates spending more time to solve complex problems

Develops a strong technical base Eases solving of the problems that require top

management involvement

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2. Organising Project Dept.

Minimises conflicts Ensures optimum balance among time cost and

performanceEnables authority and responsibility sharing• There are some pre-conditions to be fulfilled for

a Matrix Organisation Structure to be established. They are: It should be ensured that :

All the team members commit to spend full time on the project

Conflicts are resolved quickly…….

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2. Organising Project Dept.

The resources are negotiated with function and project oriented managers

The functional departments function as individual entities

• It is observed that the following are the situations which favour the implementation of the Matrix structure:

The primary output of an organisation is a complex product

The organisation serves multiple customers in different geographical locations

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2. Organising Project Dept.

A project with complex design that requires innovation is to be finished on time

Large amounts of data are required to be processed

Designing, developing and testing a product requires sophisticated skills

Resources have to be shared among different projects

The market conditions demand rapid changes in the product

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A diagrammatic representation of a Matrix Organisational Structure:

: Vertical Lines: Functional Relationships/Responsibilities; : Horizontal Lines from PMs (Project Managers) : Project Relationships/Responsibilities; : Personnel in the various departments;

PM 1

PM 2

PM 3

General Manager

General Admn. Manager

HR Manager

Produc tion Manager

Marketing/ Sales Manager

Finance Manager

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2. Organising Project Dept.

• There are three types of Matrix organisations – Weak, Balanced and Strong.

• Refer to Book by Gray and Larson and Explain these three forms.

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2. Organising Project Dept.

• Selecting an organisational structure: PM has become a specialised field due to the need for implementing complex and large projects within the defined constraints of time, cost, performance and profit.

• The traditional organisational structure have proved to be ineffective to deal with the complexities of Project Management.

• Therefore it is necessary for organisations to identify the most appropriate organisational structure for the successful execution of a project.

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2. Organising Project Dept.

• The parameters to be considered while selecting the type of organisational structure may generally include:

size of the project, duration of the project, physical location of the project, availability of resources uniqueness of the project, experience of the organisation in managing projects and transparency at the senior management level

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2. Organising Project Dept.

• According to Hobbs and Menard, the following seven factors influence the choice of PM structure:

1. Size of Project;

2. Strategic importance;

3. Novelty and need for innovation;

4. Need for integration (number of departments involved;

5. Environmental complexity;

6. Budget and time constraints and

7. Stability of resource requirements.

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2. Organising Project Dept.

• The Project Management Organisational Structure:

Every type of organisational structure has its advantages and disadvantages.

The Project Management approach proves to be an effective alternative with minimum disadvantages.

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Project Management Organisational Structure

Advantages Disadvantages

Effective project control Lack of consistency in applying company policies

Improved relationship with customers

Under utilisation of personnel

Ability to develop products faster

Low profit margins

Minimum programme cost

Increases complexity of internal operations

Improved quality and reliability

High transfer rate of personnel among projects

Enhanced profit margins Duplication of functional skills

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Advantages….. Disadvantages...

Effective and efficient control on the security of the programme

Improved result orientation

Effective coordination among the divisions working on the project

Improved morale and goal orientation among employees

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2. Organising Project Dept.

• It should be borne in mind that the change over to the Project Management structure is a huge forward leap and going back to the traditional structure is not possible.

• The Project Management structure brings in an upgradation of jobs and job profiles.

• After selecting the appropriate structure, it is necessary to select the personnel required to work on the project.

• The ‘Right People for the Right Jobs’ have to be identified and engaged for the success of the project.

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2. Role of Consultants • Role of Consultants in Project Management:As the economic growth is more than the

development of Infrastructure in India in particular and Asia in general, the development of Infrastructure has gained topmost priority.

Whether it be telecommunications, power, highways/roads, airports, seaports, water supply or sewerage disposal, all are lagging far behind the ideal levels of development as envisaged under the ‘CMP’ (Common Minimum Programme).

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2. Role of Consultants

The Government in the 11th Five Year (2007-2012) has increased the outlay in Infrastructure significantly to Rs.17,58,000 Crores (US$ 439.5 Billion) from the 10th Plan figures Rs.8,15,000 Crores (US$ 203 Billion) at 2006-07 Prices.

The major thrust areas for these investments will be in Power, Roads and Railways which account for 2/3rd of the plan outlay in Infrastructure.

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2. Role of Consultants

India’s Infrastructure investment requirements until 2010-2011, which includes investments in the transport, telecommunications, energy, and urban sectors, is estimated to be about $425 billion. Of this total, there is a $123 billion anticipated financing gap which is being sought from the Private Sector. (Study by the

International Project Finance Association-IPFA)

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2. Role of Consultants

To achieve and sustain the required level of growth, India needs to finance the infrastructure sector in trillions of rupees.

In this context, some Consultants specialise in managing these project operations.

Consultation has become a good business these days and all they require to run business is to acquire experienced employees from different fields.

Project Management consulting is one of the growing consultation businesses since, before starting any projects, more and more companies seek the services of consultancy firms for their project needs, to eliminate risk.

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2. Role of Consultants

Even big companies prefer to hire consultancy firms though they have to pay more.

Selecting a consultancy firm for project management is a little time consuming task as research is needed to find out which project management consultancy is the best for the particular project and even after selecting a consultancy, deadlines for completion of the project, fees payable etc. need to be discussed and finalised.

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2. Role of Consultants

• “It is common today, for a key team member to be appointed as manager for a business critical project.

• This individual normally has excellent “technical” knowledge of the project.

• The million $ question is, do they have the systems, competence and available time, to project manage professionally?

• The statistics suggest probably not. • Most project management surveys in the last

decade indicate that many projects fail to successfully meet their objectives...........

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2. Role of Consultants

• ………… – just think of the disappointed customers, advantaged competitors, and lost profits that result.

• Those companies who have recognised the potential for savings have employed dedicated Project Managers, either interim or on the payroll, with mixed success.

• Recruitment is the first challenge – what do you look for? Many business leaders have heard of qualifications such as APM, PRINCE, PMI, and the like, but are not sure what they mean.

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2. Role of Consultants

• Nor do they understand the relevance and appropriateness for their business.

• Integration into the business is the next problem: – are there suitable project management

processes and tools/templates in existence in the business to be used?

-- or are the Project Managers (PM) left to their own devices?

• The final big challenge is performance. • Are the PMs delivering as well as they could and

should?

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2. Role of Consultants

• There is a clear need for a framework of measurement and improvement. This need is often overlooked.”

• This is where the professional Project Management Consultant comes in to perform and deliver the targeted results.

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2. Role of Consultants

Pricing and cost recovery, generating new sources of revenues to finance the infrastructure are some of the critical areas where consultants can provide workable solutions.

The 1992 UN Conference on Environment and Development helped to put sustainable development on the agenda.

(See more details in the Notes) As a result, environmental consideration plays a very

significant role in development projects, particularly those relating to infrastructure, and especially if they are funded by the international lending agencies like the IBRD or the ADB.

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2. Role of Consultants

Management consultants can meet the challenge of balancing economic and environmental considerations in practice, by assessing the environmental impacts, suggesting the measures for their mitigation and identifying the economic costs of environmental degradation, so that pricing of infrastructure services takes these costs into account.

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2. Role of Consultants

Consultants can play a significant role in the transformation process, by acting as an interface between the bureaucratic government and the investors waiting for the unsaturated giant market to wake up.

There is a lot of scope for the consultant to support the setting up of legal and organisation structures to meet the needs and objectives of the public sector in this regard.

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2. Role of Consultants

To develop and sustain an effective, efficient and economical administrative machinery, which is creative and adaptable to the dynamic forces of the future, it is essential to have suitable organisation structures, human resources policies, and systems and procedures, which should strive to motivate the employees and at the same time satisfy the public at large.

The government’s lack of effective initiatives in framing an investment-friendly and transparent framework have kept even the genuine investors away and confused.

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2. Role of Consultants

Therefore there is an urgent need to have a pool of knowledge systems which would have credibility with the government as well as with the investors.

Consultants can precisely fill this gap by providing a multi-disciplinary, multi –functional and multi-sector think-tank matured with the experience acquired over the years.

Management consultancy is about effecting change. It is in effect, a catalyst and a multiplier, rapidly dispersing new knowledge, new skills, and new capabilities through the economy.

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2. Role of Consultants

Consultants can help to develop a systematic approach to evaluating the range of institutional options in the infrastructure sectors to take stock of the lessons or experience and identify best practices, and to accelerate and focus the learning process.

The challenges from the environment are such that conventional wisdom and approaches may not suffice, and have to give way to more creative solutions.

It would be worthwhile making consultants intellectual partners in the effort.

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2. Role of Consultants

In short, the consultants take care of the variety of tasks in the management of a project, which can be generally summarised as follows:

Policy and institutional framework, including thrust areas for investment, norms for setting up projects and financing them, organisations involved, and the regulatory framework-including centre-state matters;

Advisory services, such as project formulation, covering scouting, feasibility and modalities, liaison and documentation, environmental and sociological issues, and sectoral expertise;

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2. Role of Consultants

Financing mechanisms, for stakeholders, including government, debt and/or equity participation, and alliances, both domestic and foreign;

Techno-sociological management synergy, to bring about collaborative efforts of specialists, community, government and other stake holders.

Thus the consultants with their expertise in all the areas related to project executions and a clinical professional approach, play a very important role in Project Management.

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3.Project Identification : Selection of

product Selection of a Project: A Project or Projects

selected should be integrated with the Strategic Plan of the Organisation.

• Project Management is at the apex of strategy and operations.

• The Project Managers need to understand the Organisation’s Mission and Strategy.

The Strategic Management Process: “What we are?” “What we intend to be?” “How we are going to get there?”

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3.Project Identification : Selection of product

Four activities of the Strategic Management Process:

Review and define the organisational Mission;Set long-range goals and objectives;Analyse and formulate strategies to reach

objectives and Implement strategies through projects.Mission statements may change….Then the

whole strategy has to also change accordingly.

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• Characteristics of the objectives “SMART”:Be Specific in targeting an objective;Establish a Measurable indicators(s) of

progress;Make the objective Assignable to one person

for completion; (or Achievable)State what can Realistically be done with the

available resources and State when the objectives can be achieved, that

is (Time) duration.

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3.Project Identification : Selection of product

• Effective Project Portfolio Management System: Avoids THE IMPLEMENTATION GAPS; Avoids ORGANISATION POLITICS and Manages RSOURCE CONFLICTS AND

MULTITASKING.

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3.Project Identification : Selection of product

• Classification of the Projects:

Compliance (and must do) (Regulatory or Emergency);

Operational (Improving efficiency of the existing systems) and

Strategic.

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3.Project Identification : Selection of product

• Selection of Projects - Criteria:

Financial and

Non financial: To capture larger market share; to make it difficult for competitors to enter the market; to develop complementary products to develop core technology for use in next generation products; to reduce dependency on unreliable suppliers; to prevent government intervention and regulation.

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3.Project Identification : Selection of product

Selection of Product:The search for promising project ideas is the first

step towards establishing a successful venture. Theoretically, a number of projects are available

for any entrepreneur. The key to success lies in getting into the right

business at the right time. The identification and implementation of good

ideas contributes significantly to the success of a project.

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3.Project Identification : Selection of product

The generation of ideas and opportunities requires imagination, creativity, sensitivity to the dynamic external environment and a realistic assessment of the firm’s capabilities.

The Project Manager’s innovative efforts have to take into account the ever changing customer-needs and preferences, new technologies, the speed at which the products and their technologies become obsolete, and the existing and future potential competition.

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3.Project Identification : Selection of product

The important dimensions which are to be probed thoroughly before making the choice are: Product/service, market, technology, equipment, scale of production, location, incentives available and time phasing.

Do you recall Porter now? Project identification is also concerned with

collection, compilation and analysis of economic data for the eventual purpose of locating possible opportunities for investment and for the development of such opportunities.

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Porter’s 5 Forces Analysis

There is also the sixth force-The ‘Complementor’ - the word coined by Andrew

Grove to denote the Govt. or the Public.

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3.Project Identification : Selection of product

Drucker classifies the opportunities into three kinds:

Additive - which enable the decision-maker to better utilise the resources without in any way changing the character of business, create minimum disturbance to the existing state of affairs and hence the least risk.

Complementary – introduction of new ideas, and so, lead to a certain amount of change in the existing structure; and

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3.Project Identification : Selection of product

Breakthrough – fundamental changes in both the structure and character of business.

Risk is greater in the ‘complementary’ but the most in the ‘breakthrough’.

As the risk increases, so is the requirement of more precise definition of the scope and nature of the project objectives and the necessity to select the best possible approach so as to minimise the resource consumption and risks and to optimise the return or gains.

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3.Project Identification : Selection of product

• New ideas for projects are thrown up by many situations, like magazine articles etc. Some examples are:

The dearth of a particular product or service; The availability of a specified type of raw

material (Presence of a skilled artisans in an area…);

Observation of the existing processes (Eg. A factory using a particular machine deciding to manufacture the machine itself.)

Analysis of the performance of the existing industries: profitability, capacity utilisation…

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3.Project Identification : Selection of product

Examination of the inputs (availability, time lag, transportation costs, economies of scale…), outputs (resultant by products, wastes…)

Review of Imports and exports (trend, import substitution…, products which have export potential….)

The statistics given by the magazines about the availability of various products;

Research Institutes (CSIR etc…new technologies,, processes etc…);

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3.Project Identification : Selection of product

The Plan document and various departmental publications of the Government.

(Annual Publication ‘Guidelines to Industries’ by the Dept. of Industrial Development: Structure, location, production performance, licensed and installed capacity, exports, various incentives available, future scope…)

Studies of the State Financial Institutions and Development Agencies:

(Feasibility studies for establishment of new industries in various areas in their states…)

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3.Project Identification : Selection of product

Study of the reports of the different Product Group Manufacturers’/ Industries’ Associations;

Analysis of Economic and social trends: (changing habits of people to use more and more sophisticated products, indulging in leisure activities…)

Consumption of products in foreign countries which can fulfil the needs of the local public;

Study of sick units for possibility of revival;Products reserved for the SSI/SME sector listed by

the Governments for their exclusive purchases.

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3.Project Identification : Selection of product

• The entrepreneur is concerned with identifying a particular product that can be marketed successfully at a reasonable profit.

• A good project contains four critical elements: “The right project at the right time at the right

place and at the right price”.• If the entrepreneur himself has adequate

experience in the manufacture and marketing of certain products, then it would be to his advantage to select the product/s, subject to the other criteria being fulfilled.

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3.Project Identification : Selection of product

Identifying the market:• Out of the many project ideas thrown up from

different sources as discussed above, the market for the product has to be identified.

• A short list may be made of only those products which can satisfy the Michael Porter’s 5 force model and the Life Cycle approach ( Stages of a product : Pioneering or Infant, Rapid Growth, Maturity or Stabilisation and finally the Decline).

• The market can be identified from some of the sources indicated for selecting the project.

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3.Project Identification : Selection of product

• “One should either identify a need and fill it or create a need and fill it”.

• The classification of the consumers on the basis of income groups, demography (age groups), industries, geographical locations, sex will indicate the potential market.

• Seasonal factors, disposable incomes, ruling prices, fashion also indicate the potential market.

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3.Project Identification : Selection of product

• The study of the project idea is the starting point of the feasibility analysis

-- which is undertaken to identify the logic of the project, the tasks that must be performed to achieve the objectives, the inputs, the outputs and the process involved in each activity.

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3. Preparation of feasibility study/report :

• Preparation of feasibility study/report :• The stating point of a project analysis is the

establishment of objectives to be attained. The next stage is the pre-selection stage – to decide whether to go in for an in-depth study or not.

• A feasibility study is an analysis of the viability of an idea through a disciplined and documented process of thinking through the idea from its logical beginning to its logical end.

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3. Preparation of feasibility study/report :

• A feasibility study provides an Investigating function that helps answer “Should we proceed with the proposed project idea? Is it a viable business venture?”

• A feasible business venture is one where the business will generate adequate cash flow

and profits, the business will withstand the risks it will

encounter, the business will remain viable in the long-term,

and the business will meet the goals of the founders.

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3. Preparation of feasibility study/report :

Why a Feasibility Study?• To provide a thorough examination of all issues and

assessment of probability of business success,• To give focus to the project and outline alternatives,• To narrow down business alternatives,• To unearth new opportunities through the

investigative process,• To identify reasons NOT to proceed,• To enhance the probability of success by addressing

and mitigating factors early on that could affect the project,

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3. Preparation of feasibility study/report :

• To provide quality information for decision making,

• To help to increase investment in the company,• To provide documentation that the business

venture was thoroughly investigated,• To help in securing funding from lending

institutions and other monetary sources.Data required for a feasibility study can come

from primary or secondary sources.• Primary data can include formal interviews and

surveys.

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3. Preparation of feasibility study/report :

• Collection of primary data can be expensive and time consuming

• Secondary data can include industry and trade publications, statistics of industry associations, government agency reports (CSO)

A feasibility study of an idea is conducted at five levels

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3. Preparation of feasibility study/report :

Financial Analysis : Profitability , BEP, Level of risk:

Financial statements: total project cost, initial capital requirements, cash flows relative to the project schedule,

Financial projections for future time periods,: income statements, cash flows and balance sheets,

Supporting schedules for the financial projections, stating the assumptions made regarding the collection period of sales, credit period for purchases and expenses, production cost, selling and admn. Expenses and financial expenses.

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3. Preparation of feasibility study/report :

Financial analysis showing returns on investments, returns on equity , break-even volume and price analysis.

Sensitivity analysis /Risk analysis to identify items which have a substantial impact on profitability.

Technological Analysis : Scale of operation, Process chosen, Equipment & Machinery.

Description of the product including specification relating to its physical, mechanical and chemical properties and uses of the product,

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3. Preparation of feasibility study/report :

Description of the selected manufacturing process, showing detailed flow charts and presenting alternative processes which may have been considered and the justification for the adoption

Determination of the plant size, and production schedule, including the expected volume for a given period on the basis of start-up and technical factors of the selected process.

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3. Preparation of feasibility study/report :

Selection of machinery, equipment, including specifications, equipment to be purchased, its origin, quotations from suppliers, delivery dates, terms of payment, comparative analysis of alternatives in terms of cost, reliability performance and spare parts availability,

Identification of plant’s location and an assessment of its desirability in terms of distance from raw material sources and markets, a comparative analysis of different sites, indicating the advantages and disadvantages of each.

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3. Preparation of feasibility study/report :

Design of the plant layout and an estimate of the cost of the proposed buildings and land improvements,

Availability of the raw materials and utilities including a description of physical and chemical properties, quantities needed, current and prospective costs, terms of payment, location of sources of supply and continuity of supply,

Estimate of labour requirements, including a detailed break-down of direct and indirect labour requirements, and the supervision required for the manufacture of the product,

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3. Preparation of feasibility study/report :

Determination of the type and quantity of waste to be disposed of together with a description of the waste disposal method, its costs, and the necessary clearance from proper authorities,

And an estimate of the production cost of the product, etc…

Economical Analysis : From the point of view of the Society, Impact on society, Impact on saving & investment.

Contribution to the national economy: raising of aggregate consumption, redistribution of income.

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3. Preparation of feasibility study/report :

Market Analysis : Aggregate demand, Market share.

The market analysis should cover the following areas:

A brief market description including the market area, modes of transportation and costs, channels of distribution, and general trade practices;

An analysis of past and present demand, determination of quantity, value of consumption and identification of the major consumers of the product;

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3. Preparation of feasibility study/report :

An analysis of past and present supply, broken down as source – whether imported or domestic- as well as information to assist in determining the competitive position of the product, such as selling prices, quality and marketing practices of competitors.

(projections for the future also are required for the above factors).

Ecological Analysis : Effect on environment damage, Cost to prevent the damage:

Study of different types of potential environmental pollution: gaseous emissions, noise heat and vibrations while manufacturing of the product and disposing of the wastes/effluents.

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3. Preparation of feasibility study/report :

Cost of restoration in the unfortunate event of damages (eg. Union Carbide…)

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Generation of

ideas Initial

Screening Is the idea Prima Facie

Promising?

Plan Feasibility Analysis

Yes

Terminate

No

Conduct Market Analysis Conduct Technical

Analysis

Conduct Financial Analysis

Conduct Economic and Ecological Analysis

Is the Project worthwhile ?

Prepare Funding Proposal

Terminate

Yes No

P R E L I M I N A R Y W O R K A N A L Y S I S

E V A L U A T I O N

Feasibility Study – A Diagrammatic Representation

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3. Project Rating Index:

Project Rating Index:The preliminary evaluation results of various

projects in view may be translated into a Project Rating Index. How to do it?

Identify the factors relevant for the project rating,Assign weights to these factors depending upon

their relative importance and criticality,Rate the project proposals on various factors,

using a rating table,( a 5, 7 or 10 or any desired scale may be used),

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3. Project Rating Index:

For each factor, multiply the factor weight with the assigned rating and note the score,

Add all the factor scores to arrive at the overall Project Rating Index,

Compare the Project Indices of the various short-listed projects with the pre-determined desired minimum Rating,

Select the best of the projects whose ratings exceed the predetermined minimum rating.

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3. Project Rating Index:

• Refer to text books to see the numerical example of project ratings.

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4. Project formulation.

• Project Formulation techniques help in making the final choice of a project.

• Project formulation is the presentation of the Project idea which makes it easy to compare with the other project ideas.

• Project Formulation (PF) is defined as taking a first look carefully and critically at a project idea by an entrepreneur to build up an all round beneficial project after carefully weighing its various components.

• The aim of project formulation is to derive maximum benefits from minimum expenses in a short span of time.

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4. Project formulation.

• Steps in Project Formulation: Recall what we have already seen earlier:

• A project comprises of a series of activities for achieving a predetermined objective or a set of objectives.

• And therefore the objective(s) should be defined as precisely as possible.

• Objectives may be General or may be Operational.• A general objective merely states in broad terms

the achievements expected whereas an operational objective specifically mentions the results expected from the implementation of the project.

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4. Project formulation.

• The next stage is about the location and size of the project.

• The seven distinct sequential stages in Project Formulation are:

• 1.Feasibility Analysis: At this stage, the project idea is examined to decide whether to go in for a detailed investment proposal or not.-(Technical Feasibility; Economic Viability; Commercial Feasibility; Financial Feasibility; Organisational Aspects; Legal Aspects)

• (If feasible: proceed to the next step; If not feasible: drop the project idea; If unable to decide for want of sufficient data: Collect more data).

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4. Project formulation.

• 2.Techno-Economic Analysis: Estimation of the project demand potential and choice of optimal technology are made.

The Techno-Economic analysis gives the project a unique individuality and sets the stage for detailed design development.

• 3.Project Design and Network analysis : This step defines the individual activities which constitute the project and their inter-relationship with each other.

A detailed work plan of the project is prepared with time allocation for each activity and presented in a network drawing.

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4. Project formulation

Project design is a critical element of the project and paves the way for a detailed identification and qualification of the project inputs, which are essential to develop the financial and cost-benefit profile of the project.

• 4.Input Analysis : This step assesses the input requirements during the construction as well as during the operation of the project.

The details of the inputs required at each stage should be prepared to arrive at the total requirements of the inputs for the project-both quantitatively as well as qualitatively.

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4. Project formulation

Both recurring and non-recurring requirements of inputs are taken into account.

An evaluation is made from the point of view of the availability of the required resources.

This will help in arriving at the project cost which in turn will help a proper financial and cost-benefit analysis.

• 5.Financial Analysis: This stage involves estimating the project costs, operating costs and funding requirements.

It also helps comparing different projects on a common scale.

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4. Project formulation

The tools used are DCF, CVP and Ratio analysis.

Since project investments are for long time horizons, it is absolutely necessary to exercise due care and foresight in developing project financial forecasts.

• 6.Social Cost Benefit Analysis: While Financial analysis will justify a project from the point of view of profitability, the Cost-Benefit Analysis will consider the project from the national viability point of view.

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4. Project formulationIn this analysis, we not only consider the apparent

direct costs and direct benefits of the project, but also the costs which all entities connected with the project have to bear and the benefits which will be enjoyed by all such entities.

This strategy is now an international norm for project formulation.

• 7.Pre Investment Analysis: The project proposal gets a final shape at this stage.

All the results obtained from the previous stages are consolidated and various conclusions are arrived at to present a clear picture.

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4.Evaluation of Risks:

At this stage, the project is presented in such a way that the project sponsors, the implementers and the external consulting agencies are able to take a final decision as to whether to accept the project proposal or not.

• Evaluation of Risks: Risk is the possibility of an outcome being

different from the expected outcome, the possibility of adverse results flowing from the uncertainty involved in carrying out the activities.

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4.Evaluation of Risks:

Every activity of a project is exposed to some degree of risk. Project is a function of uncertainty and damage.

Both these factors should be thoroughly examined while conducting the risk analysis.

The project manager should also provide for hazards and the appropriate safeguards to mitigate the risks.

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4.Evaluation of Risks:

• Based on the principle that a risk has two primary dimensions:

• Probability - A risk is an event that "may" occur. The probability of it occurring can range anywhere from just above 0% to just below 100%. (Note: It can't be exactly 100%, because then it would be a certainty, not a risk. And it can't be exactly 0%, or it wouldn't be a risk.)

• Impact - A risk, by its very nature, always has a negative impact also. However, the size of the impact varies in terms of cost etc.

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4.Evaluation of Risks:

• The chart has these characteristics:• Low impact/Low probability - Risks in the bottom left

corner are low level, and you can often ignore them.• Low impact/High probability - Risks in the top left

corner are of moderate importance - if these things happen, you can cope with them and move on. However, you should try to reduce the likelihood that they'll occur.

• High impact/Low probability - Are of high importance but they're very unlikely to happen. For these, however you should have contingency plans in place.

• High impact/High probability - These are your top priorities, and are risks that you must pay close attention to.

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4.Evaluation of Risks:

Some of the risks that arise in a project are:1.Technical risks: These risks refer to the failure

to meet a particular performance requirement. Failure of the feasibility of a design, changes in

technology etc. are some of the sources. Software modules running well in small scale fail

when integrated with some other modules. Technology obsolescence before the project is

ready to start commercial production

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4.Evaluation of Risks:

2.Social risks: Changes in the needs and preferences of the target customers.

Labour unrest, strikes, and social movements against the project (Example: Population displaced due to acquiring of land for a new project).

3.Economic Risks: Increase in the rate of inflation, changes in the economic policies of the government.

No control of project manager over these risks and so extra provisions while preparing projections even at planning stage.

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4.Evaluation of Risks:

4.Political risks: Nationalisation or privatization of an industry. Political instability.

(The project manager should analyse the policies of the ruling party as well as the main opposition party)

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4.Evaluation of Risks:

5.Production risks: Shortage of necessary RM, breakdown of machinery, rise in installation and maintenance costs.

(These can be generally forecast at periodic intervals and hence safeguards can be built into the plan).

6.Marketing risks: Failure of the developed product or service in the market due to changes in the market demand, errors in forecasting the demand at the planning stage…

(The Project manager should change the strategy)

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4.Evaluation of Risks:

7.Financial risks: Bad debts, increase in interest rates, mistakes in accounting procedures.

(Project manager has to constantly assess the project on these parameters so as to take corrective actions.)

8.Human risks: Sudden demise or resignation of key employees, non availability of competent employees, inter-group politics and rivalry among employees.

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4.Evaluation of Risks:

(Project manager should evolve suitable HR policies and implement them and also take group insurance schemes to reduce the sufferings of the families of the deceased employees)

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4.Risk Management

Risks can never be avoided completely. Appropriate tools have to be used effectively to mitigate the risks.

The timing and use of the tools depends on the ‘risk tolerance’ level of the project manager.

Project managers may be ‘risk averse’ or ‘risk neutrals’ or ‘risk seekers’.

When the investment amount goes up, the utility-the satisfaction-- that the project manager gets—of the risk averse project manager increases at a decreasing rate.

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4.Risk Management

For a risk seeking project manager, utility increases at an increasing rate as the investment at stake goes up.

The risk neutral project manager’s utility lies in between the other two.

The PMBOK defines risk management as “the formal process by which risk factors are systematically identified, assessed, and provided for.”

The project manager has to be proactive rather than reactive while dealing with risks.

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4.Risk Management

The proactive project manager anticipates the risks and is ready with contingency plans whereas the reactive project manager waits for the risk to become visible as a problem and then starts thinking of solving the problem.

Certainty, risk and uncertainty: o Project managers have to take many decisions

under conditions of certainty, risk and uncertainty.

o Decision making is easy in conditions of certainty.

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4.Risk Management

o The process becomes increasingly difficult as the condition changes from certainty to risk and to uncertainty as the expected potential damage to the project increases.

o Decision making under certainty: o The project manager is fully aware of all the

states of nature (the future events that are not in the control of the project manager) available and the expected payoffs for each state of the nature.

o The project manager can construct a payoff matrix for all the states of nature and select the best possible strategy.

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4.Risk Management

o First the project manager formulates the strategy for each of state of nature.

o Then all the possible outcomes for each action, under each state of nature are recorded to complete the payoff matrix.

o Homework: Prepare a sample pay off matrix for decision making under certainty. (See Chapter18 of IC).

o Decision making under risk: PMBOK: “Risk is the totality effect of outcomes (i.e. states of nature) that can be described within established confidence limits (i.e. probability distributions).

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4.Risk Management

o Under conditions of risk, the project manager can assign probability of occurrence to each state of nature with which he can also calculate the expected value for each of the strategies and finally select the best strategy earning higher returns.

o The expected value of a strategy is the sum of the products of the probability of a state of nature and the respective payoff value of a strategy. Homework: Construct a sample payoff matrix for decision making under risk.

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4.Risk Management

o Decision making under uncertainty: In this case the project manager does not know the probability of occurrence of each state of nature.

o He uses four types of criteria to select a strategy:

• Maximax criterion (Hurwicz criterion): The project manager chooses the strategy that is likely to earn him the highest returns;

• Maximin criterion (Wald criterion): The project manager identifies the minimum payoff values of each strategy and adopts the strategy that has the highest payoff value.

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4.Risk Management

• Minimax regret criterion: The project manager attempts to minimise the maximum regret value (maximum opportunity loss).

• The regret value is arrived at by subtracting the pay off values in each state of nature from the largest payoff value of that state of nature. (The matrix is created from the matrix of decision making under risk)

• Criterion of realism. (Laplace criterion) : As per this criterion, each state of nature has the same probability of occurrence.

• So the project manager considers the average value of all the payoffs for each strategy and selects the strategy that has the average highest payoff.

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4.Risk Management

Decision Tree analysis: This analysis is used when a decision involves a series of several unrelated decisions. The project manager computes the Expected Monetary Value (EMV) of all strategies and chooses the strategy with the highest EMV.

Homework: Prepare a sample Decision Tree.

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4.Risk Management

• Risk Management Methodology: Steps involved: • Risk identification: Source of risks, potential

risk events, and risk symptoms.• Risk quantification: Decision trees, simulation,

PERT and CPM, Probability distribution. • Risk response: Risk avoidance, Risk transfer,

Risk mitigation and Risk acceptance. • Risk control: Corrective actions, Updates to risk,

Management Plan.

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The Risk Management

Process

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4. Preparation of Project Report:

• Preparation of Project Report:• Usually, the project report is prepared before the

investment in the project is undertaken, as it is the basis on which the whole project proceeds and the financiers also assess the project’s viability on the basis of the project report, so as to take the decision whether to lend or not.

• The project report records the merits and demerits in allocating resources to production of specific goods or services.

• It gives a complete analysis of the inputs and outputs of the project.

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4. Preparation of Project Report:

• Usually the promoter of the project gets the report prepared by consultants who are experienced in the line and that too in the areas of the product or service proposed in the project.

• The Scope of the project report covers the following aspects:

• Economic aspects: Economic justification for investment, analysis of the market :

how big is the present market and potential for future growth?

what could be the market share in future assuming new entrants?..

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4. Preparation of Project Report:

• Technical aspects: Details about the technology needed and where it is presently used successfully, equipments and machinery needed, their suppliers and report about their performance efficiency..

• Financial aspects: Total investment required, breakup of promoter’s contribution, sources of finance for the balance viz, equity/preference equity from public, debentures, term loans, cost of capital , return on equity, return on investment, cash flows for the tenure of the loan sought, D/E ratio, DSCR….

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4. Preparation of Project Report:

• Production aspects: Description of the product selected, its design, and the reasons for the selection, whether can be exported and if so, which are the markets…..

• Managerial aspects: Qualifications and experience of the key management team in the line of the product or service..

(Production Manager, Marketing/Sales Managers, Purchase manager, HR manager, other managers well conversant with Labour laws, Factory acts, tax laws and other laws concerned with running such establishments)

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4. Preparation of Project Report:

• The contents of a project report will consist of the following:

Objective and scope of the report;Product characteristics;Market position and trends (installed capacity,

production and anticipated demand, export prospects, price structure and trends);

Marketing channels (trading practices and marketing strategy);

RM ( requirement in quantity, prices, sources of supply and their properties, transportation);

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4. Preparation of Project Report:

Manufacture (process, selection of process, production schedule and technique);

Plant and machinery ( equipments, machinery, instruments, lab equipments, electric load, water supply);

Land and building (land area, building, construction schedule);

Personnel (requirements of staff at various levels, labour and their availability, cost of labour..)

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5.Selection of location and site of the project:

• Selection of location and site of the project:• Location of the site and plant are critical to the

operation of the set up in an interruption-free manner.

• An ideal site not only saves on costs but also enhances productivity and profits.

• The need for a new location arises when: 1.an enterprises starts a new project for production

of a product or service;2.an existing enterprise goes for an expansion of

capacity or diversification of its product range and the existing location cannot accommodate additional work space;

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5.Selection of location and site of the project:

3. a necessity arises to shift the existing plant to another location due to various factors – like depletion of raw materials in near by areas, or lease of the land expires and the co. is unable to extend the lease etc.

• A good location enables the enterprise to function smoothly, efficiently and with minimum cost. whereas wrong location leads to wastage in efforts and talents of the promoters.

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5.Selection of location and site of the project:

• According to Bethel, Atwater and Smith, enterprise location involves three main steps which are: 1.Selection of the region or general area; 2. Selection of a particular community or locality and 3. selection of the exact optimum plant site.

• Sometimes the choice of the location is not that of the promoters but that of the Government due to licensing regulations (example: Chemical Zone, Pharmaceutical Zone etc).

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5.Selection of location and site of the project:

• Location is extremely important from another point of view also: availability of social infrastructure like, reasonably good housing, schools/colleges, hospitals, recreation facilities etc. if best talent is to be attracted and retained.

• In the case of export oriented industries, location near an airport/sea port would be preferred.

• Power hungry industries should avoid power deficit locations. (Example: Aluminium Industry)

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5.Selection of location and site of the project:

• Nearness to a heavy industrialised area has its advantages in respect of infrastructure but has also a disadvantage in the form of spread of unionism, even if the employees may not have any grievance against he unit.

• The factors affecting the location of an enterprise can be listed as follows:

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Urban Area Rural Area•Possible to find existing building to house factory.

•Cost of land is less & scope of future expansion is more.

•Easier to sell building later.

•Healthy & pleasant atmosphere.

•Power & water easily available.

•Cheapness of land allows freedom for most economic design for building.

•Good market for small mfrs.

•Lesser taxes & restriction.

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•Housing, banks, fire protection, railways & education available.

•Housing can be provided by pvt. Enterprise or local authority.

•Transportation is easy & cheap.

•Road or rail connection can be arranged easily.

•Workers find easy to change job & area has good labour market.

•Less labour trouble & labour is cheap.

•Repairing facility available with existing industries.

•Opportunity to exchange knowledge from nearby industries.

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Urban area Rural area

•Climate is not healthy due to congestion.

•Sufficient power & water may not be available.

•Arranging equipment is not possible due to limited area.

•Enough facilities for expansion may not be available.

•High taxes. •No recreational facilities.

•Cost of land is high & scope of expansion is less.

•Transport & housing facilities may not be satisfactory.

•More problems about labour & employee relations

•Government facilities may not be sufficient.

•Cost of building factory will be high.

•Skilled workers are not easily available.

•Higher wages of labour due to high standard of living.

•Educational facilities may not be available.

Urban area Rural area

•Climate is not healthy due to congestion.

•Sufficient power & water may not be available.

•Arranging equipment is not possible due to limited area.

•Enough facilities for expansion may not be available.

•High taxes. •No recreational facilities.

•Cost of land is high & scope of expansion is less.

•Transport & housing facilities may not be satisfactory.

•More problems about labour & employee relations

•Government facilities may not be sufficient.

•Cost of building factory will be high.

•Skilled workers are not easily available.

•Higher wages of labour due to high standard of living.

•Educational facilities may not be available.

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Selection of Region Selection of Community/location Availability of RM Availability of labour

Nearness to market Civic amenities for workers Availability of power and fuel Existence of complementary and

competing industries Transport Banking/Finance and Research

facilities Suitability of climate Availability of water and fire fighting

facilities Government policy Local taxes and restrictions

Competition among states Momentum of an early start Meteorological conditions and

topography Communication facilities

Cultural affinity and harmony Religious and social institutions Educational environment Historical factors Political stability

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Selection of site Optimum selection of site Soil, size and topography

Waste disposal Price of land, right and title of the land

Potential for expansion Commercial services/Communication

facilities Health of locality, good scenery

Statutory considerations Flood and drought experience

Attitude of local people State Assistance

Optimum site is selected on the basis of a comparative economic survey of the alternative sites in aquestion.

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5.Selection of location and site of the project:

• Generally speaking, if the value addition is low, then the location may be near the source of RM, (For e.g.: Textile and sugar mills in Maharashtra, Sugar factories in U.P, Marble mfrg. in Jaipur, Sandal Wood products in Mysore, fish-canning & salt pans near coast, Export of Alphonso mangoes from Ratnagiri.)

• --but if the value addition is high then the location may be chosen considering the other more important critical factors since transportation costs can be absorbed.

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5.Selection of location and site of the project:

• A recent survey found that most of the SMEs had their location near their residence and had ignored the economics of the location of the industry. More than 50% of these SMEs had failed within five years.

• There are two types of measures that may be adopted by the Govt. to influence the location: They are: Positive measures and Negative measures.

• POSITIVE measures encourage growth by various inducements extended to the industrialists to setup their projects in certain specified areas.

• NEGATIVE measures impose restrictions on the location of projects in certain congested areas.

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5.Selection of location and site of the project:

• Both sets of measures are necessary for the effective location policy.

• If more resources are invested in one region, less resources will be available for investment in other regions.

• In cities with population of more than 1 million, there is no requirement of obtaining industrial approvals from central government, if the plant is to be located beyond 25 Kms. of periphery of the cities.

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5.Selection of location and site of the project:

• Weber’s Theory of Industrial Location: (Alfred Weber: was a professor at the University of Heidelberg from 1907 to 1933):

• Two types of materials used in an industry: • Ubiquitous: available everywhere- like brick,

clay, water etc.• Localised materials (which are available only in

certain localities –like ores minerals etc.): again these are of two types : weight losing and weight gaining.

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5.Selection of location and site of the project:

• Weight losing materials lose considerable weight during the process of manufacture- like, coal.

• Such industries should be located near the source of RM

• Weight gaining materials are those which become heavier than the raw materials after manufacture- for example, water added to the raw material to make the final product. and require transport.

• Such industries should be located near the market.

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5.Selection of location and site of the project:

• Industries get redistributed in different localities due to the ‘deglomerative’ forces.

• ‘Agglomeration’ is the phenomenon of spatial clustering, or a concentration of firms in a relatively small area.

• The clustering and linkages allow individual firms to enjoy both internal and external economies.

• Auxiliary industries, specialized machines or services used only occasionally by larger firms tend to be located in agglomeration areas, not just to lower costs but to serve the bigger populations.

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5.Selection of location and site of the project:

• ‘Deglomeration’ occurs when companies and services leave because of the diseconomies of industries’ excessive concentration.

• Firms who can achieve economies by increasing their scale of industrial activities benefit from agglomeration.

• However, after reaching an optimal size, local facilities may become over-taxed, lead to an offset of initial advantages and increase in Project cost

• Then the force of agglomeration may eventually be replaced by other forces which promote deglomeration.

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5.Selection of location and site of the project:

• His theory has five assumptions. • His first assumption is known as the isotropic

plain assumption. This means the model is operative in a single country with a uniform topography, climate, technology, economic system.

• His second assumption is that only one finished product is considered at a time, and the product is shipped to a single market.

• The third assumption is raw materials are fixed at certain locations, and the market is also a known fixed location.

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5.Selection of location and site of the project:

• The fourth assumption is that labor is fixed geographically but is available in unlimited quantities at any production site selected.

• The final assumption is that transport costs are a direct function of weight of the item and the distance shipped.

• Selection of the most Economic site: According to Kimball, “the most advantageous location is that at which the cost of gathering material and fabricating it plus the cost of distributing the finished product to the customer will be minimum”.

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Selection of Actual Site:

Items of cost Cost per unit at the site

Site A Site B Site C

Fixed Capital (Land, building, equipment..)

Cost of production and distribution: ( Materials cost, Labour cost, Overheads-taxes, insurance, depreciation)

Total:

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5.Selection of location and site of the project:

In order to arrive at the final decision for the most economic site, a comparative statement as shown above has to be prepared for all the alternative sites.

• Factory Layout Planning: • Factory Design – it is the plan for a particular

type of building, arrangement of machinery and equipment, and provision of service facilities, lighting, heating, ventilation, etc. in the building.

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5.Selection of location and site of the project:

• It influences the operational costs, boosts the morale of the workers and ensures maximum supervision.

• It must be flexible so that it may be easily adapted to technological change, modernization, diversification and expansion with minimum cost and time.

• Factors to be considered – • Knowledge of what is involved in the activity

concerned, such as the nature of materials to be handled………

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5.Selection of location and site of the project:

• ,………. their quality and quantity, the process they have to be subjected to, inspection and quality control at various stages, assembly procedures, packing, etc.

• The sequence of operations• Movement of materials from one stage to

another should be minimum.• Plant layout – is a floor plan for determining and

arranging the desired machinery and equipment of a plant in one of the best place.......

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5.Selection of location and site of the project:

• …….. to permit the quickest flow of materials at the lowest cost and with the least amount of handling in processing the product from the receipt of the raw materials to the shipment of the finished products.

• It not only covers the initial layout of machines and other facilities but encompasses improvement in, or revision of, the existing layout in the light of subsequent developments in the methods of production.

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PLANT

MARKET/VENDORS

WASTE DISPOSAL

ELECTRICITY WIRES

CLIMATIC CONDITIONS

GAS

WATER

HOUSE FOR LABOURERS

RAW MATERIAL

SCHOOL GYMKHANA

SPORTS

BANK

COMPETITORS

REGION

LOCALITY

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MEASURE OF SIZE

INPUT(a.) Net worth(b.) Size of assets(c.) Employment(d.) Raw materials required(e.) Power needed(f.) Number and capacity of plant

OUTPUT(a.) Volume of output(b.) Value of output

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5.Selection of location and site of the project:

Factors for evaluating Plant Layout:• Production technology and Product-mix• Efficient, economic and uninterrupted flow of

human and materials resources• Proper space for maintenance• Future expansion / diversification of the project• Safety precautions particularly when explosive

or bulky material is required to be handled

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5.Selection of location and site of the project:

• Proper lighting and ventilation• Proper layout of utilities and services and

provisions for effluent disposal• Effective supervision of work• Proper storage and stacking space Importance of Layout:• Effective use of available area• Minimization of production delays• Improved quality control• Minimum equipment investment• Avoidance of bottlenecks

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5.Selection of location and site of the project:

• Better production control and supervision• Improved utilization of labour• Improved employee morale• Maximization of production• Avoidance of unnecessary and costly changes• Increased revenues and profits• Success of the enterprise

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5.Selection of location and site of the project:

Factors affecting Factory Layout:• Nature of product (light or heavy products)• Volume of production (high or low)• Materials handling• Type of equipment (specifications of machinery

and equipment–general / specialized machines)• Factory building• System of manufacture (i.e. process of

manufacture)• Lighting and ventilation

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5.Selection of location and site of the project:

• Service facilities (canteen, drinking water, toilets, first aid, fire escapes, etc)

Materials Handling:• “The right equipment, at the right position, to be

worked in the right manner for completing the manufacturing process in the SHORTEST possible time.

• This includes that the layout should be such that the new materials, stores, intermediate stores and work places should be interlinked so that the production may flow uninterruptedly.

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5.Selection of location and site of the project:

• A good layout not only improves material handling operations but also increases the production and productivity per employee.

• Handling adds nothing to the value of the product, but only to the cost.

Advantages of Materials Handling:• Reduced labour cost• Increased capacity of existing building• Better machine utilization

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5.Selection of location and site of the project:

• Less capital tied-up in work-in-progress• Easier stock control• Less fatigue for operations• More efficient production control• Better inspection and control of quality• Improved safety

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5.Selection of location and site of the project:

In short a Good Plant layout can be defined as:

• “a floor plan for determining and arranging the

desired machinery and equipments of plant,

whether established or contemplated in the best

place, permit the quickest flow of material at the

lowest cost and with the least amount of handling

in processing the product from the receipt of the

raw material to the shipment of finished goods”

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‘S’ Type

R

FG

Combination of ‘T’ and ‘U’ Type

FGR

‘O’ Type or Circular Flow

R

FG

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FGR

Ground FloorFG

R

First Floor

Second Floor

Third Floor

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6.Policies of Central and State Governments towards location, Legal

aspects of Project managementAs per World Economic Forum’s Global

Competitiveness Review 2010-11: 139 countries compared.

Parameter Rank -India Rank-China

Quality of Education System 39 – 4.3/7 53 – 4/7

Quality of Management Schools 23 – 5.1/7 63 – 4.2/7

Availability of specialised research and training services

51 – 4.4/7 50 – 4.4/7

Intensity of local competition 30 – 5.4/7 19 – 5.6/7

Extent of market dominance 26 – 4.7/7 23 – 4.8/7

Extent and effect of taxation 36 – 4/7 29 – 4.1/7

Number pf procedures required to start a business

121 -13 126 -14

Time required-no. of days- to start a business 93 - 30 108 - 37

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Parameter Rank - India

Rank - China

Prevalence of Trade barriers 96 – 4.2/7 69 -4.6/7

Prevalence of foreign ownership 81 – 4.6/7 103 -4.4/7

Business impact of rules on FDI 46 – 5/7 18 – 5.4/7

Burden of customs procedures 81 – 4/7 46 – 4.5/7

Pay and productivity 61 – 4/7 15 – 4.7/7

Reliance on Professional Management

49 – 4.7/7 50 – 4.7/7

Brain Drain 34 – 4.3/7 37 – 4.3/7

Availability of Financial Services 45 – 5.1/7 71 – 4.6/7

Financing through local Equity Market

10 – 4.7/7 52 – 3.8/7

Ease of access to loans 39 – 3.3/7 51 – 3/7

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Parameter Rank - India

Rank - China

Venture Capital Availability 31 – 3.1/7 27 – 3.3/7

Restriction on Capital Flows 75 – 4.4/7 123 – 3.3/7

Soundness of Banks 25 – 5.8/7 60 – 5.3/7

Regulation of Securities Exchanges 15 – 5.3/7 61 – 4.4/7

Availability of latest technologies 41 – 5.6/7 94 – 4.4/7

Domestic Market Size Index 4 – 6.1/7 2 – 6.6/7

Foreign Market Size Index 4 – 6.2/7 1 – 7/7

GDP (PPP) 4 2

Exports as a percentage of GDP 117 – 20.6 88 – 27.9

Business – Local Supplier Quality 60 – 4.6/7 54 – 4.7/7

Nature of (International) Competitive advantage

61 – 3.4/7 48 – 3.7/7

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Parameter Rank - India

Rank - China

Production Process sophistication 43 – 4.3/7 55 – 3.9/7

Quality of Scientific Research Institutions

30 – 4.7/7 39 – 4.3/7

Availability of Scientists and Engineers

15 – 5.2/7 35 – 4.6/7

Utility Patents per million population 59 – 0.6 51 – 1.2

The report contains ranking of 139 countries on 12 broad parameters (listed in the next slide) (and sub-parameters under them). Only a few have been listed above so as to give a rough idea of where we stand which in turn will give some ideas as to the areas in which projects can be thought of. See the website of World Economic Forum for the full text of the report.

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This table is from the last year’s report

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6.India .. At present:• Sourced from: The Secretariat of Industrial Assistance

(SIA), (Dept. of Industrial Policy and Promotion-DIPP, Ministry of Commerce and Industry).:

• Brand India: R & D base for 100 of the 500 Fortune Companies.

• Among the only three Asian countries with super computing competence.

• Strong Base for manufacturing: Most MNCs like Toyota, Volvo, Ford, GM etc source components from India and also manufacture in India; Hyundai’s car manufacturing facility in India is the global base for exports of its small cars.

• Hero Honda is the world’s largest motorcycle manufacturer.

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6.India .. At present:

• Abundant availability of untapped natural resources, rich mineral base, and agricultural self-sufficiency.

• Large and expanding consumer market with increasing purchasing power for branded consumer products.

• Large manufacturing capability, spanning almost all areas of manufacturing activities, unskilled, semi skilled and skilled labour availability at competitive wages.

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6.India .. At present:

• All the above are statements of facts and made possible by the proactive steps taken by the Govt. of India by liberalising and globalising the Indian economy.

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6.Industrial Policy..DIPP: Established in 1995 -- Responsible for

formulation and administration of industrial policy.

Functions: 1. Monitoring industrial growth – infrastructure,

technology, environment etc2. Approval of Foreign Technology collaborations

and forming policies3. Formulation of FDI policy4. Promotion of Non Resident Investment5. Policies related to IPR, Trademark, Patents etc6. Development of Industrial corridors as well as

backward states

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6.Industrial Policy.. Main features of the Industrial Policy of Govt. of India:

Objectives:• to maintain a sustained growth in productivity;• to enhance gainful employment;• to achieve optimal utilisation of human resources;• to attain international competitiveness and• to transform India into a major partner and player in

the global arena.Policy focus is on : • Deregulating Indian industry;• Allowing the industry freedom and flexibility in

responding to market forces and• Providing a policy regime that facilitates and fosters

growth of Indian industry.

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6.Industrial Policy.. Policy measures:• Some of the important policy measures announced

and procedural simplifications undertaken to pursue the above objectives are as under:

• i) Liberalisation of Industrial Licensing Policy• The list of items requiring compulsory licensing is

reviewed on an ongoing basis. At present, only five industries are under compulsory licensing mainly on account of environmental, safety and strategic considerations.

• (1.Alcoholics drinks; 2.Cigarettes and tobacco products; 3.Electronic Aerospace and Defence equipment; 4.Explosives; 5.Hazardous Chemicals such as Hydrocyanic Acid, Phosgene, Isocyanates and Di-Isocyanates of Hydrocarbon and derivatives)

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6.Industrial Policy.. At present, industrial license is required only for the

following: -1. Industries retained under compulsory licensing2. Manufacture of items reserved for small scale

sector by larger units3. When the proposed location attracts locational

restrictionSimilarly, there are only three industries reserved for

the public sector.• (1.Arms & Ammunition and the allied items of

defence equipments, defence air-crafts and warships; 2.Atomic Energy; 3.Railway transport)

• ii) Introduction of Industrial Entrepreneurs’ Memorandum (IEM)

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6.Industrial Policy..

• Industries not requiring compulsory licensing are to file an Industrial Entrepreneurs’ Memorandum (IEM) to the Secretariat for Industrial Assistance (SIA). No industrial approval is required for such exempted industries. Amendments are also allowed to IEM proposals filed after 1.7.1998.

• iii) Liberalisation of the Locational Policy• A significantly amended locational policy in tune with

the liberalised licensing policy is in place:• No industrial approval is required from the

Government for locations not falling within 25 kms of the periphery of cities having a population of more than one million except for those industries where industrial licensing is compulsory.

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6 6.Industrial Policy..

• Non-polluting industries such as electronics, computer software and printing can be located within 25 kms. of the periphery of cities with more than one million population.

• Permission to other industries is granted in such locations only if they are located in an industrial area so designated prior to 25.7.91. Zoning and land use regulations as well as environmental legislations have to be followed.

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6.Industrial Policy..

• iv) Policy for Small Scale Industries• Reservation of items of manufacture exclusively

for the small scale sector forms an important focus of the industrial policy as a measure of protecting this sector. Since 24th December 1999, industrial undertakings with an investment upto rupees one crore are within the small scale and ancillary sector.

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6.Industrial Policy..

• A differential investment limit has been adopted since 9th October 2001 for 41 reserved items where the investment limit upto rupees five crs. is prescribed for qualifying as a small scale unit. The investment limit for tiny units is Rs. 25 lakhs.

• 749 items are reserved for manufacture in the small scale sector. All undertakings other than the small scale industrial undertakings engaged in the manufacture of items reserved for manufacture in the small scale sector are required to obtain an industrial license and undertake an export obligation of 50% of the annual production.

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6.Industrial Policy..

• This condition of licensing is, however, not applicable to those undertakings operating under 100% Export Oriented Undertakings Scheme, the Export Processing Zone (EPZ) or the Special Economic Zone Schemes (SEZs).

• V) Non-Resident Indians Scheme• The general policy and facilities for Foreign

Direct Investment as available to foreign investors/company are fully applicable to NRIs as well.

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6.Industrial Policy.. • In addition, Government has extended some

concessions specially for NRIs and overseas corporate bodies having more than 60% stake by the NRIs.

• These inter-alia includes (i) NRI/OCB investment in the real estate and housing sectors upto 100% and (ii) NRI/OCB investment in domestic airlines sector upto 100%.

• NRI/OCBs are also allowed to invest upto 100% equity on non-repatriation basis in all activities except for a small negative list. Apart from this, NRI/OCBs are also allowed to invest on repatriation/non-repatriation under the portfolio investment scheme.

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6.Industrial Policy..

• vi) Electronic Hardware Technology Park (EHTP)/Software Technology Park (STP) scheme

• For building up strong electronics industry and with a view to enhancing export, two schemes viz. Electronic Hardware Technology Park (EHTP) and Software Technology Park (STP) are in operation.

• Under EHTP/STP scheme, the inputs are allowed to be procured free of duties.

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6.Industrial Policy..

• The Directors of STPs have powers to approve fresh STP/EHTP proposals and also grant post-approval amendment in respect of EHTP/STP projects as have been given to the Development Commissioners of  Export Processing Zones in the case of Export Oriented Units.

• All other applications for  setting up projects under these schemes, are considered by the Inter-Ministerial Standing Committee (IMSC) Chaired by Secretary (Information Technology). The IMSC is serviced by the SIA.

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6.Industrial Policy..

• vii) Policy for Foreign Direct Investment (FDI)• Promotion of foreign direct investment forms an

integral part of India’s economic policies. • The role of foreign direct investment in accelerating

economic growth is by way of infusion of capital, technology and modern management practices.

• The Department has put in place a liberal and transparent foreign investment regime where most activities are opened to foreign investment on automatic route without any limit on the extent of foreign ownership.

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6.Industrial Policy..

Some of the recent initiatives taken to further liberalise the FDI regime, inter-alia, include:

• opening up of sectors such as Insurance (upto 26%);

• development of integrated townships (upto 100%);

• defence industry (upto 26%); • tea plantation (upto 100% subject to divestment

of 26% within five years of FDI); 

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6.Industrial Policy..

• Enhancement of FDI limits in private sector banking,

• allowing FDI up to 100% under the automatic route for most manufacturing activities in SEZs;

• opening up B2B e-commerce; Internet Service Providers (ISPs) without Gateways;

• electronic mail and voice mail to 100% foreign investment.

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FDI RestrictionsFDI up to 100% is allowed under the automatic route

in all activities/sectors except the following:

1.Sectors prohibited for FDI

2.Activities/items that require an industrial license

3.Proposals in which the foreign collaborator has an existing financial/technical collaboration in India in the same field

4.Proposals for acquisitions of shares in an existing Indian company in financial service sector and where SEBI (substantial acquisition of shares and takeovers) regulations, 1997 is attracted

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FDI Restrictions….

5. All proposals falling outside notified sectoral policy/CAPS under sectors in which FDI is not permitted

6. The sectors that are not in the automatic route, investment requires prior approval of the Central Government. The approval in granted by Foreign Investment Promotion Board (FIPB).

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Prohibited Industries for FDI

The extant policy does not permit FDI in the following cases:

Gambling and betting Lottery Business Atomic Energy Retail Trading Agricultural or plantation activities of Agriculture (excluding Floriculture, Horticulture, Development of Seeds, Animal Husbandry, Pisiculture and Cultivation of Vegetables, Mushrooms etc., under controlled conditions and services related to agro and allied sectors) and Plantations (other than Tea Plantations)

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6.Industrial Policy..

• The Department has also strengthened investment facilitation measures through Foreign Investment Implementation Authority (FIIA).

• Trade Policy Reforms: Most items freely importable, quantitative restrictions lifted.

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6.Industrial Policy..

• Monetary Policy and Financial Sector Reforms: Securitisation Act for better security for creditors; Competition law enhanced and Competition Commission constituted.

• Independent Regulators SEBI and IRDA in place. Rationalisation of Tax Structure: Reduction in peak customs tariff from 300% in 1991 to 25% in 2004;

• Special investment and tax incentives for exports in certain sectors such as power, software, electronics, BPO and food processing.

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6.Industrial Policy..

• Conducive foreign investment environment that provides freedom of entry, investment, location, choice of technology, production, repatriation of capital, dividends etc. which are specifically aimed at enhancing the flow of FDI.

• IPR initiatives taken : IPR laws are TRIPS compliant; IPR appellate Tribunal functional from 2003; Digital database library of patents, trademarks and design records.

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6.DIPP: Annual Report 2007 – 08:

• With the progressive liberalization of the Indian economy, initiated in July 1991, there has been a consistent expansion in the role and functions of this Department.

• From regulation and administration of the industrial sector, the role of this Department has moved to facilitation of technology and investment flows and promotion of industrial development in the liberalized environment.

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6.DIPP: Annual Report 2007 – 08…

• The role and functions of the Department of Industrial Policy and Promotion (DIPP) primarily include: -

• Formulation and implementation of industrial policy and strategies for industrial development in conformity with the developmental needs and national objectives, in order to make the Indian industry internationally competitive;

• Monitoring and stimulation of industrial growth in general, and performance of industries specifically assigned to it in particular and guidance in the creation of an enabling environment, infrastructure, technology transfer/ collaborations on all industrial and technical matters;

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6.DIPP: Annual Report 2007 – 08…

• Approval of foreign technology collaborations at enterprise level and formulation of policy parameters for the same, for enhancing productivity, with reference to international benchmarking;

• Formulation of Foreign Direct Investment (FDI) Policy and amendments thereto as well as promotion and facilitation of direct foreign and non-resident investment in industrial and service projects;

• Association, as nodal department, for investment related issues in Bilateral/regional economic Cooperation Agreements;

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6.DIPP: Annual Report 2007 – 08…:

• Formulation of policies relating to Intellectual Property Rights in the fields of Patents, Trademarks, Industrial Designs and Geographical Indications of Goods and administration of regulations and rules made thereunder;

• Administration of Industries (Development & Regulation) Act, 1951;

• Promotion of Industrial development of industrially backward and remote, hilly and inaccessible areas of the Special category States of ……

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6.DIPP: Annual Report 2007 – 08…:

• ……North Eastern Region including Sikkim), Jammu & Kashmir, Himachal Pradesh and Uttarakhand through special incentive packages;

• Promotion of international cooperation through productivity, quality and technical cooperation;

• Compilation of data/statistics on Foreign Direct Investment & analysis thereof ; and

• Compilation of monthly industrial production statistics for use in the construction of Index of Industrial Production (IIP).

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6.DIPP: Annual Report 2007 – 08:

• The Department is responsible for formulation and implementation of promotional and developmental measures for growth of the industrial sector, keeping in view the national priorities and socioeconomic objectives.

• While individual Administrative Ministries look after the production, distribution, development and planning aspects of specific industries allocated to them, this Department is responsible for the overall Industrial Policy.

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6.DIPP: Annual Report 2007 – 08..:

• This Department is the nodal organization for the promotion of productivity in the industrial sector.

• It undertakes programmes of technical cooperation with the Asian Productivity Organization (APO), Tokyo, by sourcing experts to advise on productivity related projects and by deputing officials from the private and public sector to programmes conducted by the APO in industry, agriculture and service related sectors.

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6.DIPP: Annual Report 2007 – 08…:

• It also promotes the adoption of quality standards relating to the ISO 9000/14000 series through the accreditation services provided by National Boards for Certifying Bodies and Auditors and Trainers under the Quality Council of India, which has been certified by international accreditation bodies.

• Schemes For Industrial and Infrastructure Development:

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6.DIPP: Annual Report 2007 – 08..:

• This Department administers the Industrial Infrastructure Upgradation Scheme (IIUS) for enhancing the competitiveness of the domestic industry by providing quality infrastructure through public-private partnership in selected functional clusters. Central assistance up to 75% of the project cost subject to a maximum of Rs. 50 crs. is provided under the Scheme

• FDI Promotion Initiatives : Several steps have been initiated to facilitate increased FDI inflows which include, inter-alia, the following:

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6.DIPP: Annual Report 2007 – 08:

• (a) On the policy front, while our FDI policy is already very liberal, the policy is being further progressively rationalised.

• (b) On the investment promotion front, the Department organises Destination India events in association with CII and FICCI.

• (c) The Foreign Investment Implementation Authority (FIIA) has been activated towards speedy resolution of investment related problems.

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6.DIPP: Annual Report 2007 – 08:

• (d) National Manufacturing Competitiveness Council has been set up to provide a continuing forum for policy dialogue to energise and sustain the growth of manufacturing industries.

• (e) The Department has regular interaction with foreign investors. Such interactions have been held in bilateral/ regional/ international meets such as Indo- ASEAN, Indo-EU, Indo-Japan, etc. Meetings with individual investors were also held on a regular basis.

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6.DIPP: Annual Report 2007 – 08:

• (f) The Department website ( www.dipp.nic.in ) has been made both comprehensive and informative with online chat facility. About 4500 investment related queries were replied during the year.

• Investment Climate : The advantages of India as an investment destination rest on strong fundamentals which include:

• a large and growing market; world-class scientific, technical and managerial manpower; cost effective and highly skilled labour; abundant natural resources; a large English speaking population and an independent judiciary etc.

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6.DIPP: Annual Report 2007 – 08:

• This is now recognised by a number of global investors who have either already established a base in India or are in the process of doing so.

• Ongoing initiatives, such as further simplification of rules and regulations and improvement in infrastructure are expected to provide necessary impetus to increase FDI inflows in future. .

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6.DIPP: Annual Report 2007 – 08:

• All the State Governments offer some or the other incentives to Industrialists to induce them to invest in their states – so that the economy of the state can grow at the needed pace.

• Rehabilitation and resettlement policy and associated legislative measures relating to land acquisition : (Press Information Bureau , Government of India, 11/10/2007):

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6.Rehabilitation and Resettlement Policy:

• The new Policy and the associated legislative measures aim at striking a balance between the need for land for developmental activities and, at the same time, protecting the interests of the land owners, and others, such as the tenants, the landless, the agricultural and non-agricultural labourers, artisans, and others whose livelihood depends on the land involved.

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6.Rehabilitation and Resettlement Policy:

• The benefits under the new Policy shall be available to all affected persons and families whose land, property or livelihood is adversely affected by land acquisition or by involuntary displacement of a permanent nature due to any other reason, such as natural calamities, etc.

• The Policy will be applicable to all these cases irrespective of the number of people involved.

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6.Rehabilitation and Resettlement Policy:

• The benefits to be offered under the new Policy to the affected families include; land-for-land, to the extent Government land would be available in the resettlement areas;

• preference for employment in the project to at least one person from each nuclear family within the definition of the ‘affected family’, subject to the availability of vacancies and suitability of the affected person;

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6.Rehabilitation and Resettlement Policy:

• training and capacity building for taking up suitable jobs and for self-employment;

• scholarships for education of the eligible persons from the affected families;

• preference to groups of cooperatives of the affected persons in the allotment of contracts and other economic opportunities in or around the project site;

• wage employment to the willing affected persons in the construction work in the project;

• housing benefits including houses to the landless affected families in both rural and urban areas; and other benefits.

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Industrial Park Scheme, 2002:

• Objectives of the industrial park: setting up of an Industrial Model Town for development of

industrial infrastructure for carrying out integrated manufacturing activities including research and development

an industrial park for development of infrastructural facilities or built-up space with common facilities

the Growth Centre is distinctly developed as a separate profit centre.

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6.National Design Policy:

• FDI Policy: See the detailed chart in the notes:• National Design policy: Objectives: preparation of a platform for creative design

development, design promotion and partnerships

presentation of Indian designs and innovations on the international arena

attracting investments, including foreign direct investments, in design services and design related R & D;

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6.National Design Policy:

global positioning and branding of Indian designs

well defined and managed regulatory, promotional and institutional framework raising Indian design education to global standards of excellence.

making India a major hub for exports and outsourcing of designs and

creation of awareness among manufacturers and service providers, particularly SMEs and cottage industries

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6.National Design Policy:

• Action plan : Setting up of specialised Design Centres or

“Innovation Hubs” for sectors such as automobile and transportation, Jewellery, leather, soft goods, electronics / IT hardware products, toys & games which will provide common facilities and enabling tools like rapid product development, high performance visualisation, etc.

Formulation of a scheme for setting up Design Centres/Innovation Hubs

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6.National Design Policy:

Preparation of a mechanism for recognising and awarding industry achievers in creating a brand image

Encouraging Indian firms and institutions to develop strategic alliances with design firms and institutions abroad to gain access to technology and know-how improving Indian design.

four more National institutes of Design on the pattern of NID will be set up in different regions of the country

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6.National Design Policy:

Encouraging the teaching of design in vocational institutes oriented to the needs of Indian industry

Organising workshops and seminars encourage and facilitating a culture for creating

and protecting intellectual property in the area of designs

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6.Ultra mega power project (UMPP):

These are very large sized projects, approximately 4000 MW each involving an estimated investment of about Rs. 16,000 crore.

Five coastal sites at:- Mundra in Gujarat, Krishnapatnam in Andhra Pradesh, Tadri in Karnataka, Girye in Maharashtra, and Cheyyur in Tamil Nadu.

Four pithead sites at :- Sasan in Madhya Pradesh, Tilaiya in Jharkhand, Sundergarh District in Orissa and Akaltara in Chhattisgarh.

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6.Now some of the States:

• North East Industrial and Investment Promotion Policy (NEIIPP), 2007:

The North East Industrial Policy (NEIP), 1997 announced on 24.12.1997 covered the States of Arunachal Pradesh, Assam, Manipur, Meghalaya, Mizoram, Nagaland and Tripura.

Under NEIIPP, 2007, Sikkim will also be included.

Duration of incentives: All new units as well as existing units which go in for substantial expansion,will be eligible for incentives for a period of ten years from the date of commencement of commercial production.

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6.NEIIPP

Excise duty exemption: 100% Excise Duty exemption

Income Tax Exemption: 100% Income Tax exemption

Interest Subsidy: Interest Subsidy will be made available @ 3% on working capital loan

Incentives for Service/other Sector Industries : A number of tax concessions:

• Capital Investment Subsidy: Capital Investment Subsidy will be enhanced from 15% of the investment in plant and machinery to 30%

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6.NEIIPP

• the limit for automatic approval of subsidy at this rate will be Rs.1.5 crores per unit, as against Rs.30 lakhs as was available under NEIP, 1997.

• Incentives for Bio-technology industry: • The biotechnology industry will be eligible for

benefits under NEIIPP, 2007 as applicable to other industries.

• Incentives for Power Generating Industries: • Power Generating plants will continue to get

incentives as governed by the provisions of the Income tax Act.

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6.NEIIPP

• Industries Not Eligible:• tobacco and manufactured tobacco substitutes. • Pan Masala • Plastic carry bags of less than 20 microns • Goods produced by petroleum oil or gas

refineries.• Transport Subsidy Scheme -2007: • It covers all North eastern region

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6.NEIIPP

• Transport subsidy is paid on the transport cost of raw material brought into and finished goods which are taken out.

• It is available at the rate of 90% within north eastern region and at the rate of 50%for finished good from this region to other region.

• Centre gives various financial assistance limited to one-third of total cost of infrastructural development

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6.Maharashtra….Incentives:

• Ranks first among the states in terms of State domestic production accounts for 15% of the national income

• Per capita income of Rs.23,849, more than 60% higher than the national average

• Contributes 22% in organised industrial sector• 40% of internet users are from Maharashtra• 30% of software export• Well set mechanism to support industry

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6.Maharashtra….Incentives:

• Highest power generation capacity, at more than 14000MW

• More than 215 industrial estates, including 9 five star industrial estate and 63 growth centers

• 301 engineering degree/ diploma colleges• ITI’s with turnout of 160000 technocrats every

year• Literacy rate at 75%

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6.Maharashtra :Policies and Incentives

• A) New Micro & Small Manufacturing Enterprises, Medium Enterprises / LSI (including IT/ BT units)

• B) Interest subsidy:All new eligible Micro & Small Manufacturing Enterprises in textile, hosiery, knitwear and readymade garment sector will be eligible for interest subsidy in addition to Industrial Promotion Subsidy.

(See the Tables for A and B in the Notes)

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6.Maharashtra :Policies and Incentives

• C) Exemption from Electricity Duty:• 100% Export Oriented Units (EOUs), Information

Technology (IT) and Bio-Technology (BT) units will also be exempted from payment of Electricity Duty for a period of 10 years.

• D) Waiver of Stamp Duty:• C, D, D+ Talukas and No Industry Districts –

Exempted• A and B areas:• BT and IT units in public Parks : 100%• BT and IT units in private Parks : 75%• Mega Projects : 50%

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6.Gujarat

• 5 per cent of the India’s total population • 6 per cent of geographical area• Gujarat contributes to 16 per cent of the

country’s total investment• 10 per cent of expenditure• 16 per cent of exports • 30 per cent of stock market capitalization• The state’s annual growth rate has been 10 to

12 per cent for the last five years. • As per the latest data of Centre for Monitoring

Indian Economy (CMIE) of January 2003, Gujarat stands first in industrialization in India.

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6.Gujarat

• Projects worth Rs. 33,958 crore are under implementation.

• Gujarat’s State Domestic Product (SDP) rising at an average growth rate of 12.4% per annum

• Gujarat achieved as much as 35% of augmentation in its power generation capacity

• Three LNG terminals to come up.• one of the first few states in India to have

encouraged private sector investment in the infrastructure.

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6.Gujarat

• Gujarat accounts for almost 21% share in the export basket of India.

• Longest coastline of 1600 kms, dotted with 41 ports, 1 major, 11 intermediate and 29 minor ports.

• Excellent road network – exceeding 74000 kms. • Highest number of Airports in India – 11

including an international airport in Ahmedabad.• An extensive rail network connecting all major

centers in the state.

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6.Gujarat

• Largest producer of Salt and Soda Ash in the country.

• Largest grass-root Petroleum Refinery in the world operational at Jamnagar.

• Industrial Policy 2003 •Growth Policy• Power Policy • Tourism Policy • Road Policy •

Port Policy • Mineral Policy 2003•IT Policy 2006 – 2011 •BT Policy 2007 - 2012

•Disaster Management Policy

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6.GUJARAT INDUSTRIAL POLICY - 2000 (Growth Policy)

• Aims to achieve sustainable industrial development

Makes the State more attractive to accelerate further the flow of investment

Proposes to promote IT and knowledge based industries

Enhanced exports from industrial units targeted Encourages the development of small scale

industries and service sector industries

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GUJARAT INDUSTRIAL POLICY - 2000 (Growth Policy)

Promotes industries in backward areas Assistance for activities like market

development and promotion Upgradation of entrepreneurial skill of first

generation entrepreneurs Asset management fund introduced to cover

debt and equity fund for financial assistance to infrastructure projects

Encourages setting up of private sector industrial parks

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6.Schemes under Gujarat Industrial Policy - 2000

Interest Subsidy or State cash subsidy to Small Scale Industries

Scheme of Interest Subsidy to Service Sector Industries

Industrial Park Scheme - 2000 Incentive Scheme for Export Oriented Park and

Export Oriented Units Insertion of additional items of production in the

Sale Tax Eligibility Certificate Medium and Large Industries - Subsidy Scheme

2000

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6.Gujarat Industrial Policy – 2000,.. Power Policy:

Assistance for Research & Development and Patent Registration

Amendment in Financial Assistance for upgradation of quality in SSI/ Medium & Large Scale Sector

Declaration of Backward Talukas eligible for benefits

• POWER POLICY (HIGHLIGHTS) building up adequate capacity in generation,

transmission and distribution

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6.Gujarat Industrial Policy – 2000,.. Power Policy:

Achieving optimum utilisation of existing equipments

Rationalizing the tariff structure Improving quality of services thereby achieving

cost effectiveness Striving for energy conservation Encouraging power generation utilising non-

conventional sources

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6.PORT POLICY --HIGHLIGHTS

• Enhancing Gujarat’s Share in EXIM Sector • Decongesting the overburden on existing ports • Developing / upgrading port facilities at 10

locations. • Providing port facilities to promote export-

oriented industries and port-based industries entailing almost 50% of total industrial investment.

• Encouraging shipbuilding, ship repairing and manufacturing facilities

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6.PORT POLICY --HIGHLIGHTS

• Promoting coastal shipping for passengers and cargo traffic between various locations within and outside of the state.

• Supporting power plants by offering exclusive facilities for import of different power fuels.

• Attracting private sector investment in minor and intermediate ports as also at the new port locations.

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6.IT Policy 2006 – 2011

• Capital Incentive Subsidy:New IT unit will be entitled to avail capital subsidy @25% of eligible total capital investment or Rs.25 lakhs whichever is less.

• Special Incentives:There will be Special Incentives scheme for the projects with large capital base.

• Turnover incentives:• Connectivity incentives:

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6.Tamilnadu:

• One of the top three recipients of Foreign Direct Investment (FDI).

• Ranks No.1 in availability of skilled manpower in India.

• Low cost of Man power. Lower cost of living.• Largest tour-out of Engineers Technicians

(1,30,000 from a network of 252 Engineering Colleges & 210 Polytechnics).

• Tamilnadu has 3 major Ports: Chennai Ennore and Tuticorine with twin port advantage at Chennai and Ennore apart from 14 minor Ports.

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6.Tamilnadu:

• 270 passenger flight and 28 cargo flights per week at Chennai Airport-The Largest in South India.

• A total road network of 150,000 kms. • The only Power surplus state in India.• Prompt allotment of land in the industrial parks

with supporting infrastructure. • Single window facilitation to complete pre-project

documentation.

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6.Tamilnadu:

• Power and water supply, access roads and other supporting infrastructure.

• Incentive Schemes • Most Backward Areas • Backward Areas • Electronic Industries • Leather Industries • Floriculture Units • Selected Category of Industries • Mega projects

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6.Tamilnadu:

• Effluent Treatment Plants • Purchase of Generators • Employing Women Workers • Subsidy for Most Backward Areas : subsidy of

20% of fixed assets with a ceiling of rs. 20 lakhs• Subsidy For Backward Areas: A Capital Subsidy

of 15% on eligible fixed assets subject to a ceiling of Rs.15 lakhs

• Special Subsidy for Electronic Industries :20% on eligible fixed assets subject to a ceiling of RS.20 lakhs.

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6.Tamilnadu:

• Special Subsidy for Leather Industries :a Special SUBSIDY of 20% on eligible fixed assets subject to a ceiling of RS.20.00 lakhs.

• Additional Subsidy for Employing Women Workers :New Industrial units ( small, medium or major) where more than 30% of the total workers employed are women shall be eligible for an additional Capital Subsdiy of 5% of investment in eligible fixed assets subject to a ceiling of Rs.5 lakhs.

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6.Tamilnadu:

• Subsidy for Floriculture Units :capital subsidy of 20% on eligible fixed assets subject to a ceiling of Rs.20.00 lakhs.

• Generator subsidy for certain industry: 15% of cost of generator subject to maximum of rs 15lakhs.

• Special Subsidy For Selected Category of Industries

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6.Tamilnadu:

• A Special Subsidy of 10% on eligible fixed assets, a ceiling of Rs.15 lakhs

• i) Automobile Spare Parts.• ii) Drugs and Pharmaceuticals.

iii) Solar Energy Equipment and non conventional energy devices.iv) Export oriented Gold jewellery making and Diamond processing v) Pollution Control Equipmentsvi) Jute Industryvii) Sports goods and accessoriesviii) Food Processing Industry

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6. Legal aspects of Project Management:

• Legal aspects of Project Management:• The Project team should have a fundamental

understanding of the legal statutes which regulate their work. In the normal course of Project execution.

• Regulations are the basis for steady growth• They govern that everything occurs in conformity

with plans & policy adopted

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6. Legal aspects of Project Management:

• They are the process by which we check whether or not:

plans are being adhered to Environment is safe from pollution Law & order is maintained t

Any deviations for which a corrective actions needs to be taken

• The Project Team is expected to be conversant with the following acts:

• The Indian Contract Act;• State industries act

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6. The Acts:

• The factories act, 1948• Income tax act, 1981• Central sales tax & state sales tax acts• The Sale of Goods Act;• Acts relating to Life and General Insurance;• The Insolvency Act;• The Negotiable Instruments Act;• The Laws relating to Transports _Carriage of

Goods Act;• The laws relating to Sales Tax, Central

Excise and Customs;

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6. The Acts:

• The Foreign Exchange Management Act (FEMA);• Major Port Trust Act;• Transfer of Property Act;• The laws relating to mortgages;• The laws relating to land acquisition and Land

Disputes; Land Ceiling Act;• Labour Legislations –Payment of wages act, 1936;

Minimum wages act, 1948; Employees Providend Fund Act, 1952; Pension Funds/Gratuity; Employees State Insurance Act, 1948; Industrial Disputes Act,

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6. The Acts:

• Legislations concerning Environmental Pollution;• The Companies Act;• And many more which are relevant to the

activities that are undertaken in the execution of the Project.

The most important of all is the Contract Act, which pervades or touches upon every business activity.

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6. Contract Act

• Some of the situations arising out of contracts are more specifically dealt in other Acts – like the Sale of Goods Act, Transfer of Property Act. Etc.

• Hence a thorough understanding of the Contract Act is a must for a Project Manager.

Law of Agency: The Project Manager should remember that he is an Agent of the owners of the Project and is answerable to them for his actions even when they are bona-fide.

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6. Contract Act

• An agent cannot do what the principal himself cannot do.

• In case of emergencies, the Project Manager ( as the agent) has the authority to do every lawful thing necessary for the purpose of protecting his principal from loss, as would be done by a person of ordinary prudence would do to protect his interests in similar circumstances.

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6. Contract Act –IDR Act

• When an Agent does more than what he is authorised to do, and if the unauthorised acts of the agent can be separated from the authorised acts, then the Agent is liable for the consequences of the unauthorised acts.

Industries Development and Regulation Act :• The Act Provides The Conceptual And Legal

Framework For Industrial Development And Industries In India

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6. The IDR Act

• The Licensing Policy For Industries Is Determined Under This Act.

• The Act Specifies The General Requirements That Are To Be Complied With By Small-scale Units.

• ----Investment of unit in fixed assets --Nature of ownership: --Smallness of number of workers employed --Nature, cost and quality of product etc

• Section 29-B provides reservation of products for exclusive production in the small-scale sector.

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6. The IDR Act

• The Act specifically refers to only two categories of the small-scale sector: -

-Small Scale Industrial undertaking - Ancillary Industrial Undertaking

• It is capable enough of meeting the consumer goods needs of the community

• The government should keep the interest of community at uppermost in time

• Provide a support from large houses & safeguard the interest of millions of those who depend on it for their livelihood.

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6.The Factories Act, 1948

• The Factories Act is the principal legislation, which governs the health, safety, and welfare of workers in factories.

• A factory under the Act is defined as a place using power, employs 10 or more workers, or 20 or more workers without power or were working any day of the preceding 12 months

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6.The Factories Act, 1948

• Electronic Data Processing Unit or a Computer Unit is installed shall not be considered at a factory if no manufacturing process is being carried on in such premises.

• The Act does not permit the employment of women and young in a dangerous process or operation.

• Section 11 to 20 deal with various provisions such as:

• Environmental sanitation that protect the worker from hazardous environment.

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6.The Factories Act, 1948

• Cleanliness of the working place, privy, benches, stairs, wall etc. are explained

• Disposal of wastes and effluents should be without any risk

• Ventilation, temperature inside factory, dust and fumes emission, lighting, artificial humidification, overcrowding (minimum of 50 cubic meters per person) are specified

• Safety measures like fencing of machines, protection of eyes against fire, dangerous fumes, etc. are defined

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6.The Factories Act, 1948

• Facilities for sitting, canteens, first aid appliances are provided.

• There is provision for one weekly holiday, and not more than 48 hours of working in a week.

Payment of Wages Act, 1936 • It has been enacted to regulate the payment of

wages to workers employed in certain specified industries and to ensure a speedy and effective remedy to them against illegal deductions or unjustified delay caused in paying wages to them.

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6.The Factories Act, 1948

• It applies to the persons employed in a factory, industrial or other establishment or in a railway

• The act is applicable to employees drawing wages upto Rs. 1600/- a month.

• The person responsible for payment of wages shall fix the wage period upto which wage payment is to be made.

• All wages shall be paid in current legal tender, i.e in current coin or currency notes or both.

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6.The Factories Act, 1948

• All payment of wages shall be made on a working day.

• Although the wages of an employed person shall be paid to him without deductions the act allows deductions from the wages of an employee on the account of the following:-

fines Absence from duty Damage to or loss of goods by the employee Housing accommodation and amenities provided by the employer Recovery of advances or adjustment of over-payments of wages Recovery of loans made from any fund

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6.The Factories Act, 1948

• Hence, The Main Objective Of The Act Is To:• Eliminate All Malpractices• By Laying Down The Time And Mode Of

Payment Of Wages• Securing That The Workers Are Paid Their

Wages At Regular Intervals, Without Any Unauthorized Deductions

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6.Labour Laws:

Labour Laws: This is probably the most important and sensitive issue in Project Management.

So many issues like payment of proper wages at the proper time, handling of disputes, strikes, severance packages, remittance of dues to the Govt. towards Employees State Insurance, Providend/ Pension contributions to the Providend Commissioner’s Office within the stipulated time schedule etc. come under this section.

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6.Labour Laws:

So, the Project Manager has to take care to see that his team members handle such items carefully.

Employees' Provident Fund and Act, 1952 • The main objective of making some provisions

for the future of industrial workers after their retirement and for their dependents in case of death.

• It provides insurance to workers and their dependents against risks of old age, retirement, discharge, retrenchment or death of the workers.

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6.Labour Laws:

• The Act is administered by the Government of India through the Employees' Provident Fund Organization (EPFO

• Three Schemes Are In Operation Under The Act:

• Employees' Provident Fund Scheme, 1952• Employees' Deposit Linked Insurance Scheme,

1976• Employees' Pension Scheme, 1995 (Replacing

The Employees' Family Pension Scheme, 1971)

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6.Labour Laws:

• To provide the employees an old age and survivorship benefits

• A long term protection and security to the employee and after his death to his family members

• Timely advances including advances during sickness and for the purchase/ construction of A dwelling house during the period of membership.

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6. Sales of Goods Act

Sale of Goods Act: Sale contract is a bilateral contract with money consideration being a must for the sale of goods and the exact moment when the title passes on to the buyer from the seller defined clearly in the Act.

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6. Sales of Goods Act

• The Project Manager and his team should know the intricacies of this act as they may have to face many tricky situations – for example, the seller might not have delivered the goods as agreed as per time, quantity or quality etc. or the Project Finance Department might not have made the agreed payment in full.

• Any of these may cause a delay in use of the goods in question affecting the time schedule of the project.

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6. Sales of Goods Act

Central Sales Tax Act: Most of the states have agreed to change over to the ‘VAT’ system. There are differing Tax laws governing sale of goods within a state (State Sales Tax Acts) and from a place in one state to a place in another State (CST) and now the VAT.

The Project Manager and his team should be aware of the consequences of not loading the appropriate tax amount in the goods purchased for the project as any subsequent claim by the seller of the goods or the Tax authorities would inflate the cost of the project.

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6. Carriages of Goods Act

Carriage of Goods Act: A contract of carriage of goods is a contract entered into between parties for transportation of goods from the point of dispatch to the point of destination. Since the goods meant for the project have to be transported the Project Manager has to be aware of the implications of the duties and responsibilities of the sending and the receiving parties.

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6. Foreign Exchange Management Act (FEMA)

Foreign Exchange Management Act (FEMA): When goods are exported or imported or any payments are remitted abroad towards royalty or fees paid for technical drawings/designs, or for the foreign architects/technicians towards their compensation, FEMA comes into picture and care has to be taken to see that there are no violations.

Here the Bankers who deal with such transactions will guide the Project Manager properly. But part of the responsibility falls on the customer also.

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6. Negotiable Instruments act (NI Act)

Negotiable Instruments Act: This deals with the Negotiable instruments – Promissory Notes, Bills of Exchange, Cheques and Drafts.

• The makers, payees, endorsers and endorsees all have their rights and responsibilities and hence the Project Manager and his team should be fully aware of these nuances and act carefully while handling the Negotiable Instruments.

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6. Legal aspects of Project Management:

Bailment, Indemnity : These are coming out of contracts and separately elaborated. Bailment is delivery of goods by one person to another for some purpose like safe keeping etc. The bailer and the bailee have their own rights and responsibilities.

• The contract of Indemnity is defined as a contract between the promisor called the Indemnifier and the promisee called the indemnified whereby the former undertakes the responsibility of compensating any loss that the latter may suffer due to his own conduct or due to conduct of some one else. It is essentially a contingent contract.

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6. Legal aspects of Project Management:

The Excise Act: Excise is an indirect tax and is paid by the seller to the government before sending out the goods out of the factory premises and recovered from the buyer along with the price of goods.

Any goods which is sold directly from the factory premises, should always accompany the ‘Excise Gate Pass’ while on the move signifying the fact that the excise dues have been paid to the Govt.

Otherwise the Excise dept. has the powers to seize the goods . Such incidents will invariably delay the project execution.

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6. Legal aspects of Project Management:

Octroi Duties: These are levied by many Panchayats/ Municipalities/Corporations when goods of value enter their territory – except for the goods which are in transit through their territory or those which are being transported to the ports/rail heads.

Clearing the goods in Octroi check posts is a time consuming process and so the Project Management should make allowance for these delays in their project schedule.

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6. Legal aspects of Project Management:

Acts relating to Insurance: When the goods meant for the project are on the move or stored there are chances of damage and hence care has to be taken to see that the goods are covered by insurance for the value of the goods with the appropriate clauses or riders so as to minimise the losses.

Similarly when unfortunately any of the project employees die while on duty,……

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6. Legal aspects of Project Management:

• …the heavy financial compensation that may have to be paid to the family of the deceased may be shared with a Life Insurance company through ‘Group Life Insurance Policies’ which will cover all the employees.

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7.Financial analysis-Profitability Analysis.

• Financial analysis refers to the process of obtaining relevant economic information about a project in order to establish its financial viability. It is undertaken as one of the feasibility analyses in project formulation.

• Financial analysis can be defined as the process of discovering economic facts about an enterprise and or a project on the basis of an interpretation of financial data. It also looks at the capital cost, operations cost and operating revenue.

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7.Financial analysis-Profitability Analysis.

• Most of the data required for financial analysis are obtained from market analysis, technical analysis and cost analysis.

• Then the data is converted and presented in the form of Proforma Balance Sheet, Proforma Operating Statement and Cash Flow statements.

• Financial analysis primarily deals with the interpretation of the financial data incorporated in the Proforma financial statements and the presentation of the economic facts in such a form as to make a comparative evaluation/appraisal of projects.

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7.Financial analysis-Profitability Analysis.

• Financial analysis can provide insight into two important areas of management – Return on Investment and soundness of the company’s financial position.

• A financial analysis reveals where the company stands with respect to profitability, liquidity, leverage and an efficient use of its assets.

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7.Financial analysis-Profitability Analysis.

• In order to complete the financial profile of a project, it is also necessary to evaluate the operational strategy and the investment strategy of the project. The break even analysis is used to explain its operational characteristics.

• The financial strategy is evaluated in terms of financial leverage.

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7.Financial analysis-Profitability Analysis.

• The parties who have a stake in the financial results of a company are: Creditors Potential suppliers debenture holders credit institutions like banks industrial finance corporations potential investors employees trade unions important customers economists investment analysts taxation authorities Govts. et al. They all look at the financial statements from different angles.

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7.Financial analysis-Profitability Analysis.

• The principal financial tools that are relevant in this context are: trend analysis variable analysis Ratio analysis Funds Flow analysis Break -even analysis Common size analysis Cash Budgets

• Investment criteria: NPV; Benefit Cost Ratio; IRR; Pay Back period; Accounting Rate of Return.

• The NPV of a project is the sum of the present values of all the cash flows-- positive as well as negative—that are expected to occur over the life of the project:

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NPV

• The general formula for NPV is: n NPV = Ct

t =1 ----------- - initial investment (1 +r) t

--where Ct = cash flow at the end of year t; n = life of the project in years; and r = discount rate.

• (See an example in the text book – PC 8.2 to8.9 - and do some homework assuming some figures)

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NPV

• The NPV represents the net benefit over and above the compensation for time and risk.

• Hence the decision rule associated with the NPV criterion is :

--Accept the project if the NPV is +ve and --Reject if the NPV is –ve. (If NPV is 0, then the result is indifferent i.e. the

selection of the project has to depend on other factors, since the project is neither a profitable nor a losing proposition)

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NPV

Properties of the NPV Rule:• Value of a firm = PV of existing projects + NPV of future

projects• When a firm terminates an existing project which

has a negative value, the firm’s value increases by that amount.

• On the same lines, if a new project with an expected negative NPV is undertaken, the value of the firm decreases by the same amount.

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NPV

• When a firm divests an existing project, the value of the firm increases or decreases as the case may be by the same amount of positive or negative difference of the price received over the expected NPV.

• Conversely when a firm acquires an existing project, its value will increase or decrease as the case may be by the same amount of negative or positive difference of the price paid over the expected NPV;

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NPV

• Even if a firm takes up new projects with positive NPV, the value of the firm may decrease if it falls below the expectations of the investors.

• The NPV rule assumes that the cash flows that occur in between the initial outflow and the termination of the project are reinvested at the cost of capital.

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NPV

• Different discount rates for different periods may also be used in which case, the formula seen earlier has to be slightly amended as follows:

n NPV = Ct

t =1 ----------- - initial investment (1 +rt)t

where Ct = cash flow at the end of year t; n = life of the project in years; and rt = discount rate for the year t.

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NPV• This formula can again be further refined as

follows: n

NPV = Ct

t =1 ----------- - initial investment t (1 +rj)t

j = 1where Ct = cash flow at the end of year t; n = life of

the project in years; and rj = one period discount rate.

(Can you explain this concept ?) See the textbook – PC 8.2 to 8.9 - for an example

worked out with this formula.

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NPV

• The discount rate may change over time due to the reasons that :

the change in the level of interest rates over time,

the risk characteristics of the project may change over time resulting in the change in the cost of capital;

the financing mix of the project may undergo change over time resulting in the changes in the cost of capital.

NPV of a project decreases as the discount increases.

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Modified NPV

• Modified NPV: This is another method of finding the NPV, when the intermediate cash flows are reinvested at a rate different from the cost of capital and is slightly complicated than the earlier method.

• The steps are as follows: First calculate the Terminal Value (TV) of the project’s cash flows using the project’s defined reinvestment rate which is expected to reflect the profitability of the investment opportunities in the years to come.

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Modified NPV

• TV = (t = 1 to n) CFt (1+r’)n-t

Where TV = terminal value (i.e. future value) of the project’s cash flows;

- CFt = Cash Flow at the end of year t; - r’ = reinvestment rate applicable to the cash

inflows of the project.• Next determine the Modified NPV using the

formula:• NPV* = {TV/(1+r)n} - I , where NPV* =

Modified NPV; TV = Terminal Value ; r= cost of capital and I = Investment outlay.

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Modified NPV

• See an example in the text book –PC 8.8 to 8.9. • Limitations of NPV method: It ignores the relative terms and the scale of

investment but gives the absolute terms ; the life of the project is ignored ( If two projects

with different lives return the same absolute NPV, it implies that the method favours the one with longer life).

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Benefit Cost Method:

• Benefit Cost Method: Two methods are adopted:• B-C Ratio : BCR = PVB/I and• Net BCR = NBCR = (PVB-I)/I = BCR – 1.

The decision rules are:

When BCR or NBCR Rule is :

>1 >0 Accept

=1 = 0 Indifferent

<1 < 0 Reject

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Benefit Cost Method:

• Both the methods indicate the same direction• Since the criterion measures the NPV PER

RUPEE INVESTED, it can discriminate between small and big projects and short and long term projects and so better than the NPV criterion.

• The draw back is that it provides no means for aggregating several small projects into a package to compare with a larger project. Also when there are cash outflows beyond the current period, it is unsuitable.

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Internal Rate of Return (IRR):

• Internal Rate of Return (IRR): .• The IRR of a project is the discount rate which

makes its NPV = 0. • In other words, is the discount rate which

equates the present value of future cash flows with the initial investment. It is the value of ‘r’ in the following equation:

• Investment = (t = 1 to n) Ct/(1+r)t

• Where Ct = cash flow at the end of year t; r = IRR and n = life of the project.

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Internal Rate of Return (IRR):

• In the following example, where the cash flows are:

-1,00,000, 30,000, 30,000, 40,000 and 45,000,

the IRR is the value of r which satisfies the equation:

Rs. 1,00,000 = Rs.30000/1+r) + 30000/(1+r)2

+ 40000/(1+r)3 + 45000/(1+r)4

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Internal Rate of Return (IRR):

• The calculation of r involves a process of trial and error.

• At 15%, the NPV = Rs.1,00,802 and at 16%, it is 98,641.

• By interpolation it is found to be 15.37%. (Excel has a ready formula for calculating the IRR which is widely used)

• The Decision Rule is : Accept if the IRR is > cost of capital and Reject if the IRR is < the cost of capital

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NPV and IRR

Comparison of NPV and IRR:• To find the linkage between the two, let us plot

the NPV on the Y axis and the rate of return on the x axis.

• The IRR is the point at which the NPV profile crosses the x axis and the slope of the NPV profile reflects how sensitive the project is to discount rate changes.

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NPV and IRR

NPV 45000 Discount rate 15

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NPV and IRR

• Whether the IRR rule and the NPV rule lead to identical decisions?

• Yes, if: 1. the cash flows of the project are conventional, that is the first cash flow is negative and the other following cash flows are positive. and

• 2. the project must be independent i.e. the project can be accepted or rejected without reference to any other project.

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IRR

• Problems with the IRR:• When the cash flows of the project are not

conventional (cash flows can be negative in between) or when two or more projects are compared to find the better one.

• It is either difficult to define or it can be misleading.

• It cannot distinguish between short term and long term projects and also when the interest rates differ and so cost of capital also changes during the project’s life.

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IRR

• Consider a project with the following cash flows: -160000, 1000000, and -1000000.

• The IRR of the project is given by r in the equation:

• -160000 + 1000000/(1+r) -1000000/(1+r)2 = 0.

• The IRRs are 25% and 400%

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IRR

• We cannot say which of these IR is correct. Here the IRR rule breaks down.

NPV Discount rate (percentage) 25 400

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IRR

• There can also be cases when the NPV is always positive and hence no IRR (See the example in book PC 8.14)

• Mutually exclusive projects: Consider two projects : One with small investment, smaller absolute return and more IRR and another with bigger investment, bigger absolute return and smaller IRR. As per the IRR rule, the smaller project has to be selected which is wrong.

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IRR• Example: Two projects A with the cash flows: -

10000 and 20000; IRR 100% and NPV at r= 12: Rs. 7,857. and B with cash flows : -50000 and 75000; IRR 50% and NPV: Rs. 16964.

• When you look at the same projects with incremental cash flows, the IRR returns a better figure.

• In the above case, the incremental cash flows in the case of Project B are: -40000 and 55000., IRR = 37.50%, which is far above the cost of capital 12 %. Hence the project can be accepted.

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IRR

• Finally we can conclude that when we consider two mutually exclusive projects, it is better to rely on the NPV criterion.

• The case of different short and long term interest rates:

• Recall that the discount rates ‘r’ used in the denominator for the years refer to the costs of capital for the respective years.

• If the IRR is used as a decision criterion, then if the IRR> the opportunity cost, then the project can be accepted.

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IRR

• Which opportunity cost - if it changes from year to year?

• So we have to work out a weighted average of various rates and then compare it with the IRR.

• So in such cases, to avoid complications, the NPV method is preferred.

• The meaning of IRR: (1) The IRR represents the return on the

un-recovered investment balance in the project (at the same rate for the entire project life).

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IRR

(2) the IRR is the rate of return earned on the initial investment made in the project (at the same rate of reinvestment of intermediate flows).

• Since the second is not always possible we may say that the first mentioned meaning is more realistic.

• See the example in book PC 8.16-17

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IRR• The desirable qualities of IRR: Managers

look to the rate of return for their investments.

• Samuel Weaver says: “The resulting IRR can be compared to the expected inflation, the current borrowing rates, the cost of capital, an equity portfolio’s return and so on”.

• Further NPV can be calculated if you know the exact discounting rate, but still may vaguely, whereas the IRR arrives at it and so can be compared with the desired (even if not definitely known) discount rate.

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IRR

• The Modified IRR (MIRR): Whether the shortcomings of the regular IRR can be overcome?

• Yes by using the MIRR. • It is that percentage at which the costs

discounted at the cost of capital are compounded over the project life to produce the returns.

• See the following example for clarification:• The cash flows of a project are : -120, -80,

20,60,80,100,120 and the cost of capital = 15%

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IRR

• Step No. 1. Calculate the present value of costs using the formula:

• PVC + (t= 0 to n) Cash flowt /(1+r)t i.e. 120 + 80/1.15 = 189.6 assuming a cost of capital of 15%.

• Step no.2: Calculate the terminal value TV of the cash inflows using the following equation:

• TV = (t = 0 to n) Cash in flowt (1+r)n-1 i.e. :20*(1.15)4 + 60*(1.15)3……+ 120 = 467.

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IRR

• Step no. 3: Solve the following equation to find MIRR:

• PVC = TV / (1+MIRR)n.. In this case it is: 189 = 467/(1+MIRR)6.

• Thus MIRR 0.162 or 16.2%. i.e. the cost of the project is giving a return at 16.2% compounded through the life of the project of 6 years.

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IRR

• Evaluation: The MIRR is superior since the MIRR assumes that the project cash flows are reinvested at the cost of capital whereas the regular IRR assumes that the cash flows are reinvested at the project’s IRR. Secondly, the problem of multiple rates does not exist.

• So, in conclusion we can say that if two mutually exclusive projects have the same project size, NPV and MIRR lead to the same decision irrespective of the variations in the life of the projects.

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Pay back period

• Pay back period: It is the length of time required to recover the initial cash outlay on the project.

• For a project with the outflows -600000, 150000,150000,100000,1000,and 100000 the pay back period is 5 years.

• The shorter the pay back period, the better it is since the risk would be less.

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Pay back period

• It ignores the time value of money and also ignores the cash flows beyond the pay back period.

• There may be some projects with substantial cash flows beyond the Pay back period and they are all ignored.

• It is measure of the project’s recovery of the investment and about the profitability.

• It does not indicate the firm’s overall liquidity.

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Discounted Pay back period

• Discounted Pay back period method:• In the conventional Pay Back Period method the

cash flows are taken as they are without recognising time value of the flows.

• This defect is removed by discounting the flows at the appropriate cost of capital.

• See the example in book PC 8.22-24• The pay back period method can be regarded as

the reciprocal of the IRR method when the annual cash flows are constant and the life of the project is fairly long.

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Discounted Pay back period

• This method is like the Breakeven point.• The shorter the pay back period, the faster is the

uncertainty associated with the project resolved. • Accounting Rate of return:• The accounting rate of return is also called the

average rate of return on investment.

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Accounting Rate of return

• The common measures that are adopted are:• Average Income after tax/Initial investment • Average income after tax/ average investment• Average income after tax but before

interest/initial investment• Average income after tax but before

interest/average investment

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Accounting Rate of return

• Average income before interest and taxes/initial investment

• Average income before interest and taxes/average investment

• (Total income after tax but before depreciation – initial investment)/initial investment/2) x years.

• See the example in book PC 8.24-27.

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Accounting Rate of return

• Higher the accounting rate of return, the better is the project. Generally, those projects with accounting rate of return greater than the desired cut off rate of return are accepted.

• Merits of the method are:• Accounting rate of return method is simple to

calculate;• Based on accounting info which is readily

available;• Considers the benefit over the entire life of the

project;

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Accounting Rate of return

• Demerits are:• It considers accounting profit and not cash flow;• Does not take into account the time value of

money;• Accounting income is not defined since

depreciation method is not defined;• The method is misleading since balance sheet

book values reflect neither the earning capacities of the assets nor their market values.

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Assessment of various methods

• A survey by U C Rao came out with the following finds:

• Discounted cash flow methods have gained importance and IRR is the most popular method;

• Generally multiple evaluation models are used;• Accounting rate of return and pay back period

method are used as supplementary methods;

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Assessment of various methods

• Weighted average cost of capital is the most commonly used discount rate and the most often used discount rate is 15 %in post tax terms;

• Risk assessment and adjustment techniques have gained popularity and the most popular technique is sensitivity analysis. The common methods for risk adjustment are shortening the payback period.

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Social Cost Benefit Analysis (SCBA)

• SCBA is a methodology developed for evaluating investment projects from the point of view of the society as a whole.

• The methodology is used generally for public investments but it is equally important for private investments also since they have to be approved by various governmental and quasi-governmental agencies which have larger national interest in view while taking decisions.

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SCBA

• The Project Manager has to study the social costs of the project and the social and economic benefits the project will generate.

• The social costs are harmful to the society : like pollution of air, noise and water, soil erosion, deforestation, production of harmful products etc.

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SCBA

• The social and economic benefits would be: increase in employment opportunities-both directly and indirectly, rise in per capita income etc.

• The project manager has to choose the project that is beneficial to the society.

• In SCBA, the focus is on social costs and benefits which often tend to differ from the monetary costs and benefits of the project.

• The sources of the discrepancies are: market imperfections, externalities, taxes and subsidies, concern for savings, concern for redistribution merit wants etc.

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SCBA

• When imperfections exist, market prices do not reflect social values.

• The common imperfections are : • rationing (control over price and distribution – price

paid by consumer is much less than the market price),

• prescription of minimum wage rates (wages that have to be paid would be more than that would be payable in a competitive labour market),

• and foreign exchange regulation (in countries where the exchange rates are regulated, the official rate would be less than the market rate).

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SCBA

• Examples of externalities are:• beneficial infrastructure facilities created by the

project like roads which also benefit the surrounding areas

• or the bad effects of environmental pollution created by the project.

• In the first case, the project does not derive any extra benefit but the community around the project benefits without any payment.

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SCBA• In the second case, the community around the

project suffers the inconvenience but the project does not pay for it. These are relevant for SCBA.

• Taxes and subsidies: From the Project point of view, the taxes and subsidies are monetary costs and gains but from the social point of view they are simply transfer payments.

• Concern for Savings: A private firm does not have differential valuation between consumption and savings.

In the capital-scarce developing countries, a higher valuation is placed on savings and a lower valuation is put on consumption.

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SCBA

• Concern for redistribution: From the social point of view, a rupee of benefit going to an economically poor section is considered more valuable than a rupee of benefit going to an affluent section.

• Merit wants –like adult education programme or a balanced nutrition programme for school going children - are not relevant from private point of view but are important from social point of view.

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SCBA

• UNIDO approach:• UNIDO approach and the Little-Mirrlees (‘LM’)

approach emerged for SCBA in the early 1970’s.

• The UNIDO approach has been laid out in their publications: ‘Guidelines for Project Evaluation’ 1972 and ‘Guide to Practical Project Appraisal’ 1978.

• The method of project appraisal involves five stages, each one measuring the desirability of the project from a different angle:

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SCBA

• Calculation of the financial profitability of the project measured at market prices;

• Obtaining the net benefit of the project measured in terms of economic efficiency prices;

• Adjustment for the impact of the project on savings and investment;

• Adjustment for the impact of the project on income distribution;

• Adjustment for the impact of the project on merit goods and demerit goods whose social values differ from their economic values.

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SCBA

• Net Benefit in terms of Economic prices:• This is also referred to as shadow prices. When

markets are perfect, market prices will represent economic prices.

• But in reality market has so many inefficiencies which we have already discussed.

• Therefore there is a need to develop shadow prices and measuring net economic benefit in terms of these prices.

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SCBA

• Basic issues in shadow pricing: • 1.Choice of the unit of account: UNIDO’s

answer is : “net present consumption in the hands of people at the base level of consumption in the private sector in terms of constant price in domestic accounting rupees”.

• 2. Concept of tradability: For tradable goods the international price is a measure of its opportunity cost and hence represents the real value in terms of economic efficiency.

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SCBA

• 3. Sources of shadow prices: UNIDO approach suggests three sources depending on the impact of the project on the economy::

• (i) increase or decrease in the total consumption in the economy: shadow pricing is the consumer’s willingness to pay;

• (ii) decrease or increase in the production in the economy : --shadow pricing is the cost of production,

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SCBA

• (iii) increase or decrease in imports or exports : shadow pricing is the foreign exchange value.

• 4. Taxes: (i) If a project results in diversion of non traded inputs which are in fixed supply from other producers or addition to non traded consumer goods : taxes should be included;

• (ii) When the project augments domestic production by other producers, taxes should be excluded and

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SCBA

• (iii) for fully traded goods, taxes should be ignored.

• Shadow pricing of specific resources:• Tradable inputs and outputs: A good is fully

traded when an increase in its consumption results in corresponding increase in import or decrease in export or when an increase in its production results in a corresponding increase in export or decrease in import.

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SCBA

• For fully traded goods, the shadow price is the ‘border price’ which is the domestic currency equivalent converted at the market exchange rate.

• In practice, it is reasonable to regard tradable inputs and outputs as fully traded.

• For non traded goods, the border price does not reflect its economic value.

• It should be measured in terms of what domestic consumers are willing to pay if the output of the project adds to its domestic supplies or if the requirement of the project causes reduction of its consumption by others.

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SCBA

• The value of a non traded good should be measured in terms of its marginal cost of production if the requirement of the project induces additional production or if the output of the project causes reduction of production by other units.

• Non tradable inputs and outputs:• A good is non tradable when : its CIF import

price is greater than the domestic cost of production, and its FOB export price is less than the domestic cost of production.

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SCBA

• Externalities: an externality is a special class of good:

• (i) which is not deliberately created by the project sponsor but is an incidental outcome of legitimate economic activity, (ii) which is beyond the control of the persons who are affected by it, for better or for worse,

• (iii) which is not traded in the market place.

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SCBA

• Some examples already referred to earlier are: • roads built by factory being very useful for the

people around the factory or a factory emitting emissions causing injury to the health of the population around the factory etc.

• The valuation of external effects is very difficult. Because they are intangible in nature but can be estimated by indirect means:

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SCBA

• For example, the value of better transport provided by the approach road built by a factory may be estimated in terms of increased activities and benefits derived there from.

• The cost of pollution may be estimated in terms of the loss of earnings as a result of damage to health caused by it and the cost of time spent for coping with the unhygienic surroundings.

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SCBA

• Labour inputs: When a project hires labour, there can be three possible effects on the rest of the economy:

1.It may take labour away from other employments – shadow price would be what other users of labour are willing to pay for this labour,

2.It may induce the production of new workers-the social cost would be the amount of leisure that the labour foregoes, the additional consumption of food that the labour would now have as a result of increased wages and the cost of training that the worker has to undergo to improve his skills etc. and

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SCBA

3. and it may involve import of workers – shadow price would be the wage they command.

• Capital inputs: When a capital investment is made in a project,

--financial assets are converted into physical assets

--and financial resources are withdrawn from pool of savings and therefore alternative projects are foregone.

• So the questions arise as to what is the value of the physical assets and what is the opportunity cost of the capital ?

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SCBA

• The shadow price of the physical assets is calculated depending on whether it is tradable or non tradable good.

• And the opportunity cost of capital is measured by the consumption rate of interest which is the price the saver must be paid to sacrifice present consumption.

• Foreign Exchange: The UNIDO method uses the domestic currency and so the foreign exchange inputs of the project must be identified and adjusted by an appropriate premium to reflect the shadow price of foreign exchange.

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SCBA

Measurement of the impact on distribution:• For such assessments, the income gained or

lost by individual groups within the society must be measured first.

• The gain or loss to an individual group within the society as a result of the project is equal to the difference between the shadow price and market price of each input or output in the case of physical resources

• or the difference between the price paid and the value received in the case of financial transactions.

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SCBA

Savings impact and its value:• Here two questions are raised: • Given the income distribution impact of the project

what would be its effects on savings? • It is equal to Yi MPSi, where, Yi = change in

income of group i as a result of the project and MPSi = marginal propensity to save of group i.

• The second question is: What is the value of such savings to the society?

• It is the present value lf the additional consumption stream produced when that rupee of savings is invested at the margin.

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SCBA

Income distribution impact: Redistribution of income in favour of economically weaker sections or economically backward regions is a socially desirable objective.

• This cannot happen entirely through tax, subsidy and transfer measures.

• Therefore investment projects are also considered as investments for income redistribution and their contribution toward this goal is considered in their evaluation.

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SCBA

• This calls for suitably weighing the net gain or loss by each group measured earlier, to reflect the relative value of income for different groups and summing them.

• UNIDO’s guidelines suggested that the weights, which essentially reflect political judgements may be determined by an iterative process involving interaction between the analyst and the planners.

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SCBA

Adjustment for merit and demerit goods: A merit good is one for which the social value exceeds the economic value. The concept of merit goods can be extended to include a socially desirable outcome like creation of employment rather than dishing out unemployment dolls or create ‘food for work’ like jobs.

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SCBA

Little-Mirrlees (LM) approach:• IMD Little and JA Mirrlees have developed an

approach to SCBA. • There is considerable similarity between the

UNIDO approach and the LM approach.• Both call for calculating the shadow prices,

consider the factor of equity and use of DCF analysis.

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SCBA

• The differences are: • While the UNIDO approach measures costs and

benefits in term of domestic rupees, the LM approach measures costs and benefits in terms of international prices (border prices).

• The UNIDO approach measures the costs and benefits in terms of consumption whereas the LM measures in terms of uncommitted social income.

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SCBA

• The stage by stage analysis recommended by the UNIDO approach focuses on efficiency, savings and redistribution considerations in different stages, whereas the LM tends to view these considerations together.

• Shadow prices: The outputs and inputs of a project are classified into the following categories:

• 1. traded goods and services-the border price (FOB for the exported goods and CIF for the imported goods);

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SCBA

• 2. non traded goods and services - these are at accounting prices defined in terms of marginal social cost and marginal social benefit. and

• 3.labour- shadow wage rate is difficult to determine in social cost and benefit analysis.

• It is a function of several factors: marginal productivity of labour, cost associated with urbanisation, cost of having an additional amount committed to consumption due to the higher income.

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SCBA

SCBA by Financial institutions: Financial institutions analyse a project from the financial profitability angle as well as from the angle of SCBA.

• Essentially the three following aspects are covered:

• Economic Rate of Return (ERR), • Effective Rate of Protection (ERP) • and Domestic Resource Cost (DRC).

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SCBA

Economic Rate of Return (ERR): This is the rate of return the project will earn if there are no distortions.

• The flows of costs and receipts are revalued at their opportunity costs.

• The tradable inputs and outputs are valued at their international prices and the non tradable inputs and outputs are revalued at fixed conversion factors.

• Labour is revalued at the shadow wage rate.

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SCBA

• The flow of net receipts is then discounted to find the ERR. According the Planning Commission, the ERR should be at least 12% and should be more than the prevailing rate of return.

Effective Rate of Protection (ERP): This indicates the degree of effective protection that a product enjoys through its production cycle.

• The ERP measures the margin of protection on value added in the production process rather than on the product price.

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SCBA

• It is defined as the excess percentage of domestic value added due to the imposition of tariffs and other protective measures on the product and its inputs over foreign or world market value added.

• Tariffs and subsidies provide protection to domestic processing activities by raising the value added obtainable by a firm or industry.

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SCBA

• Protection permits domestic industries to operate with a value added higher than that under free trade, thereby providing incentives for the movement of scarce domestic resources into protected industries.

• The higher the ERP, the greater is this inducement, leading to economic utilisation of scarce resources.

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SCBA

Domestic Resource Cost: This is the most crucial indicator of the viability of a project especially from a macro-perspective.

• It is an indicator of the comparative advantage in any product, as it refers to the real opportunity cost in terms of domestic resources.

• It is useful in deciding whether a product should be imported or domestically produced.

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SCBA

• For the purpose of calculations, the total cost of the project is divided into two categories: rupee and foreign exchange expenditure.

• The cost components included are: total operating cost of the normal year, 8% depreciation on fixed capital and a 10% return on capital employed.

• Taxes are excluded as they are transfer payments. Sales are revalued at world prices.

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SCBA

• The rupee expenditure and foreign exchange saved/earned are calculated. The DRC is compared with the exchange rate.

• A DRC lower than the exchange rate indicates that the product could be profitably manufactured locally.

Limitations of SCBA: • Because of the nature of the social costs and

benefits there cannot be any standard method or technique applicable to all types of investments.

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SCBA

• Every project will require a different approach while identifying and measuring its social benefits and costs.

• Further many of the costs and benefits are intangible and so their valuation in terms of money is bound to be subjective due to the biases and prejudices of the analyst.

• If all possible alternative assessments are sought to be socially assessed, the costs would be prohibitive.

• However the element of subjectivity can be reduced by cross checks.

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SCBA

• In conclusion, in spite of the limitations, the gains of the social evaluation of investments cannot be disregarded.

• An awareness of the SCBA will enhance the contribution of the entrepreneurs to the society at large.

• Probably in due course of time, the social scientists will improve the methods of assessment used ion SCBA.

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8.Budget

• Budgetary control is a tool of management used to plan, carryout and control the operations of business.

• A budget is a plan of spending. It is a statement showing how a firm would allocate its resources during a given time period.

• In other words, it is a document that contains the representation of the strategy of the firm in monetary terms. It shows the resource constraints on various activities of the firm.

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Budget

• The concepts and procedures under budget plan and control have wide application not only in profit oriented enterprises but in every enterprise where the resources are limited and have to be properly applied.

• Budget plan and control is closely related to accounting. It also supplies info for marginal and standard costing and flexible budgets.

• Budget plan and control gives a firm basis for participative management.

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Budget• It requires the involvement of all management levels

in the planning process and in the approaches for accomplishing the goals.

• It enlightens the members of the management team regarding the objectives of the enterprise and its approaches. Thus it creates involvement and commitment.

• The process of preparing the budget plan consists of finalising the functional objectives and then preparing the master budget.

• First step is to forecast future targets, resolve the conflicts of sales- production-inventory problems, determine resources and cash flows.

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Budget

• The effectiveness of budget control will be enhanced if the organisation is divided into sub-units as decision centres or responsibility centres.

• Total Systems Approach:• A comprehensive budget plan and control

encompasses much more than a periodic financial budget.

• It covers all the operations in the enterprise and involves a total systems approach.

• A single high-ranking official or a committee of members should be entrusted with the responsibility of receiving and reviewing budgets from the sub-units, and consolidating them into a master budget and its periodical revision.

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Budget• The budget so prepared should be in line with the

overall comprehensive objectives of the enterprise.

• The position and forecast for the economy in general and the industry in particular, should be factored into the making the strategic long term budgets and within the overall long term budgets, short term budgets should also be prepared.

• What are the objectives of a budget?• Entrusting the individual planner at all levels with

the budget responsibilities. • Budgeting the performance and requirements of

each section and then using these budgets as targets for controlling the sections and measuring their performance.

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Budget

• Supervisors of each section should have the responsibility for the output, quality and cost.

• Budgetary control: Is a plan of operation based on a forecast of sale , income and expenditure which deals with departmental budgets framed on the basis of policy requirements and the responsibilities of supervisors. This calls for a constant comparison of the actual with the budgeted results.

• Budgetary control , also considered as a profit plan has become a means of effective management control.

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Budget

• Budgets can be broadly classified as :• Revenue and expense budgets: • Time, space, materials, and manpower

budgets;• Capital expenditure budgets;• Cash budgets;• Master operating budgets.

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Types of Budgets

Revenue and Expense Budgets

Time, Space, Materials and Manpower Budgets

Capital Expenditure Budgets

Cash Budgets Mast

er Operating Budgets

1. Sales budget is the foundation of budgetary control. 2.Operating expense budgets deal item s of expenses e.g. direct labour, materials etc.

1. Budget for direct labour hours, machine hours. 2. Budgets of units of materials, units produced

1.Financial plan for initial capital expenditure. 2. Financial plan for growth or expansion. These are tied in with long-term business planning.

They give a forecast of cash receipts and expenses. Cash budget is the most important single control of a business.

A master operating budget gathers together data from the several departments and summarises them, first in a forecast income statement and then in a forecast balance sheet.

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Budget

• Advantages of Budgetary control are:• It helps the process of panning;• It provides an effective means by which, the

entrepreneur can delegate authority without sacrificing his overall control;

• It keeps expenditure in check;• It helps in coordinating the activities of an

enterprise;• It helps in determining the policies of an

enterprise;• It aids in measuring performance;

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Budget

• It promotes cooperation and enhances controls on business activities.

• The steps involved in Budgetary control are:Preparation of the Budget, publishing

the budget, measuring the results, comparing the performance with the Budget, correcting the unfavourable variance for better growth.

• Budgeting/planning is a technique of organizing, developing and controlling business activity in a systematic manner.

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Budget

• Surprisingly many business do not have planning because:

• The uncertainties in the ever changing economic environment make the planning (with assumptions) meaningless; professional management talent is missing; the tendency to follow the age-old methods of dealing with matters; and the absence of the reliable MIS.

• In fact these are the very reasons why a systematic planning should be in place.

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Budgetary Control System – a diagrammatic representation.:

Master Budget

Sales Budget Cash

Budget Production Budget

Selling and Distribution Cost Budgets

Capital Expenditure Budget

Budget for prime costs and overhead costs

Stock Budget Administration Costs Budget

Master Budget (including Budgeted P & L A/c and Balance Sheet)

Accounting variance analysis reports and statements

Action by Management at all levels to remove variance noted in performance

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Budget

• When using budget for control, comparisons should be made between the expenditures that should have been made and actually made and not between what was allocated and actually spent.

• This comparison would bring out the real efficiency of the project.

• Budgets for the projects are prepared for one another reason also : to arrive at the proper pricing of the product.

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Budget

• There are different types of approaches to make budgets or estimates of costs. The estimating process can be classified in two ways:

• one is based on the amount of input info required and the accuracy:

• four types of estimates : • Order of magnitude analysis (used when the

project is in the conceptual stage. – cost of the project is estimated without using any engineering data, - arrived at using the past experience the output figure may be as low as 35 of actual costs-)

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Budget

• approximate estimate (also without any engineering data - made by interpolating the expenditure on similar projects undertaken earlier by making adjustments to price levels – this estimate is found to vary with the actual by about 15%) -

• Definitive estimates (are more accurate based on detailed engineering data, well laid out plans, clear specifications and reliable unit prices and may vary by a small 5% from actuals)

• and estimate using estimation manual. (in this method, estimation manuals have to be first prepared ………

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Budget

• ….. They contain standard costs for various costs. And are determined taking into account all factors such as machine down time, lunch breaks, clean up time, set up time etc. Thus this method can be used only for projects which are common with other projects based on which the manuals are developed. Even if manuals exist, they have to be constantly updated)

• The other process is based on whether the estimate is made starting at the top or bottom of the work breakdown structure.

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Budget

• In the top-down method, first the resources to be allocated for the project as a whole is estimated.

• Such estimate is broken down into various individual tasks for all the levels upto the lowest.

• In this method, the assumption is that the people at the lower level tend to overstate the resources as well as the time required to complete the project.

• Here there is no atmosphere of trust. The process may develop strains in the relationships with the staff at lower levels.

• Moreover the senior level staff do not want to share the power of decision making with the juniors.

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Budget

• The advantage in this method is that since the total budget is fixed by the top management, only the essential activities will be funded

• The other method, the bottom-up budgeting is the reverse in the approach to the top-down approach.

• The estimation starts at the smallest work element at the lowest level.

• Estimates of machine hours and man hours are then converted into rupees.

• All such estimates at all levels are aggregated to arrive at the total direct cost of the project.

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Budget

• Then the general and administrative overheads are added , some margin for contingencies and profit.

• The advantage of this method is the high level of accuracy that can be achieved.

• Since the estimates are made by all level of employees they would be fully committed to the success of the project.

• The disadvantage is the fact that on the expectation of pruning down by the seniors before finalisation, the juniors are most likely to inflate the estimates.

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Budget

• The Budgeting Process: • 1.Ideally the estimates are based on similar

tasks done earlier. • But the tasks in different projects may not be

the same and moreover it will be difficult to predict the level of prices after the lapse of a few months or years.

• 2.after aggregating all the costs and other resources needed for the whole project, and a total cost analysis is made, the task of allocation of the resources – money, equipment and people- have to be made.

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Budget

• 3.The Kick-off meeting: A meeting of all the people who are involved in the process of budget making from all the departments is called.

• In the meeting, the WBS is discussed so that every body understands the roles and responsibilities assigned – which is essential for achieving consistent and reliable estimates.

• 4. Subsequent meetings may be required for further deliberations or clarifications but only the departmental managers are called and they would be expected to coordinate the project activities of their departments with the project office.

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Budget

• 5.Underestimates in the case of an in-house project may be managed by increasing the price of the end product, but underestimates while submitting tender documents will result in loss to the firm.

• 6. Estimation of labour requirements: All the line departments estimate the labour requirements for each task assigned to them in man hours.

• The project office consolidates all the requirements to arrive at the total figure. And then converts into rupees by applying the appropriate wage rates.

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• It is a difficult exercise to predict the wage levels for the future and therefore suitable escalations have to be in built.

• 7. Estimation of overheads: Control of both the direct costs as well as the indirect costs viz. overheads is important.

• Normally overheads of a project are more than the direct costs . It would be unwise to allocate resources to the R & D dept. from the revenue that would be generated by the user department as there may be lean periods of revenue generation some time.

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Budget• 8. Estimation of materials and support services:

The quantities are estimated as per the engineering standards.

• The description of the materials required, name of the supplier, expected cost, duration of shelf life and the estimated scrap value are all the details that are passed on to the project office by all the departments.

• Estimates of expenses for support activities like expenses to be incurred on travelling, transportation of materials etc. are estimated to be 3 to 5 % of the total direct cost.

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9. Pricing the project: From the estimates of the different types of costs mentioned earlier, the cost of the total project is arrived at.

If the project is internal to the firm, then the total cost of the project arrived at will be the project budget.

But if the project is to be executed for an outside client, then the margin of profit has to be added to the total cost and quoted to the client as the price.

The margin of profit depends on whether the firm is interested in getting the contract for strategic reasons or for profit.

Price from the strategic angle will be low. Further it also depends on the stance of the competitors – whether they are also interested in the project for strategic reasons or for profit?

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• Some firms quote prices even at a loss in order to capture the contract viewing them as investments to capture more and more future contracts, income from servicing or getting into a new line etc.

• If the project is for commercial considerations, then adequate profit margin has to be added.

• If there is going to be a long time gap between quoting and executing the project appropriate cost escalation clauses have to be incorporated.

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Budget• A very low quotation also has its disadvantages : • the client may suspect the ability of the firm or the

output quality or the time required; • the funding agencies may also think on similar

lines and reject the funding proposals.• The usual pitfalls in pricing are :• Not defining the scope of the project properly;• Over optimistic project schedules resulting in

spending more on manpower than required;• Inaccuracies in the WBS;• Statement of work lacking clarity resulting in

misinterpretations;

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Budget• Mismatch in the skills required and actually

assigned;• Inadequate provisions for contingencies and cost

escalations; and• Use of inappropriate techniques for estimates. . • 10. Budgeting techniques: Two techniques which

were used earlier and not so popular are : • Zero Based Budgeting (ZBB) (Every time funds are

to be released, the projects are reviewed sometimes resulting in scrapping of the project altogether – this demoralises the people working on the project)

• and Planning, Programming, Budgeting system

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Budget• Life Cycle Costing: Earlier, the approach of the

project sponsors or entrepreneurs was to take into account all the expenditures needed to implement the project and start commercial production and look no further beyond that point.

• This is a grave mistake as can be explained with the example of a cement plant.

• A sponsor may choose to put up a plant based on the wet process since it is cheaper for commissioning but the further maintenance costs would be high.

• Whereas a plant based on the dry process would cost high initially for commissioning but further maintenance costs would be much lower.

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• Considering the life time of the project, it would be sensible to opt for a plant with the dry process.

• This is what Life cycle costing system about. In this system, choices made are evaluated against the total life cycle costs of the system.

• This system takes into account the cost of R & D, production costs, operating and maintenance costs, construction costs and phase out costs.

• Costs under these heads are calculated for each of the short listed projects and then decision is taken based on the aggregates.

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• This system has got its defects too: • Life cycle costing system is expensive and

so suitable only for large projects; • The entire exercise has to be repeated

whenever the requirements undergo a change;

• and it assumes that the life of the products is finite and is known.

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• Estimates of cash flows are a key element in any investment and is one of the most difficult steps in budget making.

• The example of the Alaska Oil pipeline would do to show how crucial is it in the process –the pipeline which was estimated to cost $700 mn finally ended up in $7 bn. (i.e. ten times the original estimate).

• This exercise involves many variables and different people participate in it:

• Capital outlays by the Engg. and product development depts.,

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• revenue projections by the marketing dept., • the operating costs by the production dept., • cost of raw materials and stores by the

purchase dept., • and then there are cost accountants, personnel

executives, and others.• The role of the finance manager is very crucial

in the process since he has to coordinate all the depts., and ensure that the forecasts are based on a set of consistent economic assumptions, with the focus on the relevant variables and as far as possible eliminate biases inherent in the process.

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Project Cash Flows • 1.Elements of the Cash flow stream:• For a project, the relevant cash flows are the

incremental post-tax cash flows. • For a conventional project they are : • the initial outlay( after tax cash outlay on

capital expenditure and the networking capital when the project is set up)

• then the operating cash flows (the after tax cash inflows resulting from the operations of the project during the economic life of the project)

• and the terminal cash flow (the after tax cash inflow due to the liquidation of the project at the end of its economic life)

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• Time Horizon for analysis: This is the minimum of the following :

• physical life of the plant ( period during which the project is physically usable condition)

• technological life of the plant (the period of time during which the technology would not become obsolete)

• product market life of the plant: (the period during which the product has a reasonably satisfactory market. The earlier two criteria may still be valid but the market for the product may diminish or even disappear.)

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• Investment planning horizon of the firm: (for infrastructure projects, the life may extend even upto 30 years)

• 2. Basic principles of cash flow estimation:• Separation principle: the cash flows out of the

investment and financing should be separated.• Take the example of a firm investing an amount

of Rs. 1000 and generates cash flow of 1200 at the end of one year i.e. the rate of return is 20%.(cash flows are -1000 and +1200).

• Suppose the entire amount of Rs. 1000 will be financed by debt at the rate of 15% pa.

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• Then the cash flows associated with the financing are +1000 and -1150. implying the cost of capital of 15%.

• The return from the project should alone be taken into account while calculating the cash flows from the project. The interest outgo of 150 is taken as the cost of capital.

• Incremental principle: The cash flow of the project must be measured in terms of incremental terms.

• This is in the case of a running firm which starts a project.

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Project Cash Flows• Project cash flow = (For an existing firm): cash

flow for the year with the project – cash flow for the year without the project.

• While calculating the incremental cash flows, one should consider all incidental effects – i.e. the project may have been incidental to add more profit for the other activities of the firm or might have taken away the incomes of the project from the other activities.

• If the project results in product cannibalisation, then if the market has no barriers and is full of competition, the cannibalisation effect has to be ignored (if considered, it may lead to wrong decisions to drop the project resulting in losing the market altogether).

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Project Cash Flows• On the other hand if there are entry barriers

and not much of competition, then the cannibalisation effect has to be considered.

• Ignore sunk costs: Supposing that a firm spends a sum of Rs.20 lakhs for conducting preliminary studies for generating information about the project, the cost is already incurred and lost anyway irrespective of whether the project is accepted or not. Such sunk costs should be ignored.

• Include Opportunity costs: When a project uses the resources already available with the firm, the opportunity costs should be taken into account.

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• Question the allocation of overhead costs: What matters is the incremental overhead costs attributable to the project . Some other overheads of the firm allocated to the project for the purpose of sharing may be ignored.

• Estimate working capital properly: The outlays have to be considered properly . The working capital at the end of the project is assumed to have a salvage value equal to its book value

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• Post tax principle:• Cash flows should be measured in post-tax

terms. Since the income from the project is marginal i.e. additional, the marginal tax rate should be considered for estimating the tax liability of the project.

• Treatment of losses: • The general principle is: • If the firm incurs losses (whether the project

alone makes profit or loss) : defer the tax savings till the firm makes profits.

• If the project loses but the firm makes profits: take tax savings in the year of loss;

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• If both the firm and the project make profits: consider taxes in the year of profit and

• In the case of a standalone project: defer tax saving until the project makes profits.

• Effect of non-cash charges: In India as per the IT act, the admissible method of depreciation for corporate taxation purposes is the written down method. (Buildings5%, Plant and machinery15%, Computers60%, Vehicles on hire 40% Pollution control equipment 100%)

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Project Cash Flows• Consistency principle:• Cash flows and the discount rates applied to these

cash flows should be consistent with respect to the investor group and inflation.

• Cash flows to all the investors : (equity holders + lenders)

• = PBIT(1-tax rate) + non cash charges –Capital expenditure –change in the working capital

• If you consider the cash flows from the point of view of the equity investors alone then it changes to :

• The figure in the previous step – preference dividend-repayment of debt +proceeds from debt issues-redemption of preference capital +proceeds from preference issues.

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• The discount rate applied for cash flow to all investors is the weighted average cost of capital and for cash flow to equity is the cost of equity.

• Generally, the cash flow to all investors is considered and hence the weighted average cost of capital is applied.

• Inflation: When the cash flows are in nominal terms, the discount rate is also nominal and if it is real cash flow then real discount rate.

• However, generally nominal cash flows are used and hence nominal discount rates should be used.

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Project Cash Flows• Cash Flow Illustrations: See PC Pages 9.10

onwards.• Viewing a project from different perspectives:• A project can be viewed from four distinct points

of view and they are:• Equity point of view;• Long term funds point of view; (Long term funds =

equity + Long term debt)• Explicit cost funds point of view: (Explicit cost

funds = Long term funds + short term debt) and• Total funds point of view. (Total funds = Long term

funds + current Liabilities)• The cash flow components slightly differ from one

another.

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In capital budgeting, the most common view is that of explicit cost funds. Examples involving this view: see exhibits 9.2 and 9.3 in PC. Net cash flows relating to explicit cost funds: Year 0 Year1… 1.Fixed Assets 2.Net working Capital 3.Revenues 4.Costs (other than dep. and interest) 5.Depreciation 6.Profit before tax: 7.Tax 8.Profit after Tax 9.Net salvage value of fixed assets 10.Recovery of nwc. 11.Initial outlay (1 + 2) 12.Operating cash inflow ( 8 + 5) 13.Terminal cash inflow (9 + 10)

14. Net cash flow (11+12+ 13)

15. Book value of investment

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• = {- equity funds committed to project + (Profit after tax – Preference dividend + depreciation +other non cash charges) + Net salvage value of fixed assets + Net salvage value of current assets – repayment of term loans –redemption of preference capital – repayment of working capital advances – retirement of trade credit and other dues. }

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Cash flows relating to equity:-Contributions made and benefits receivable by equity holders.: (See example in exhibit 9.6 in PC) Year 0 Year1… 1.Equity funds 2.Revenues 3.Operating Costs (other than dep. and interest)

4.Depreciation 5. Interest on WC advance 6.Interest on term loan 7..Profit before tax: 8.Tax 9.Profit after Tax 10.Preference dividend 11Net salvage value of fixed assets 12Net salvage value of current assets 13Repayment of term loans 14Redemption of preference capital

15Repayment of short term bank borrowings

16. Retirement of trade creditors 17.Initial investment (1) 18.Operating cash flows (9 -10 +4) 19.Liquidation and retirement cash flows (11 + 12 -13-14-15-16)

20.Net cash flow (17 + 18+19)

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• Cash flows relating to Long term funds: (see example in exhibit 9.7 in PC):

• = - (Fixed Assets + Working Capital Margin)• + {PAT + Dep. + Other non cash charges +

Int. on LT borrowings(1-t)• + Net salvage value of fixed assets + Net

recovery of working capital margin.

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Year 0 Year1… 1.Fixed assets 2.Working capital margin 3.Revenues 4. Operating costs 5.Depreciation 6. Interest on WC advance 7.Interest on term loan 8.Profit before tax: 9.Tax 10.Profit after Tax 11Net salvage value of fixed assets 12Net recovery of WC margin 13Initial investment (=1+2) 14Operating cash inflow = (10+5) +7(1-t)

15Terminal cash flow =11 + 12

16.Net cash flow (13 + 14+15)

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• Cash flows relating to total funds: (See example in exhibit 9.8 in PC)

• - Initial investment (i.e. fixed assets + current assets)

• + PAT + dep.+ other non cash charges + Int. on LT borrowings (1-tax rate) + int. on ST borrowings (1-tax rate)

• + Net salvage value of fixed assets + net salvage value of current assets.

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Year 0

Year1…

1.Total funds 2.Revenues 3. Operating costs 4.Depreciation 5. Interest on WC advance 6.Interest on term loan 7.Profit before tax: 8.Tax 9.Profit after Tax 10.Net salvage value of fixed assets 11.Net salvage value of current assets 12.Initial investment (=1) 13. Operating cash inflow = (9+4) +6(1-t) + 5 (1-t)

14.Terminal cash flow =10 + 11

15.Net cash flow (12 + 13 + 14)

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• Cash flows for a replacement project: (See example in 9.4 in PC)

• Unlike the case of new or expansion projects, estimating the relevant cash flows for a replacement project is somewhat complicated because the incremental cash outflows and inflows in relation to the existing project have to be determined. The three components of the cash flow stream for a replacement project are defined as follows:

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Net Cash Flow = (1) + (2) + (3)(1) : - Initial Investment :

- (Cost of the new assets +Net working capital required for the new asset) -

(After tax salvage value realised from the old asset + Net working capital required for the old asset)

(2): + Operating cash inflows:

+ Operating cash inflows from the new asset -

Operating cash inflows from the old asset had it not been replaced

(3): + Terminal cash flow : + After tax salvage value of the new asset +Recovery of net working capital associated with the new asset -

(After tax salvage value of the old asset, had it not been replaced + Recovery of net working capital associated with the old asset )

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Year 0 Year1… I: Investment outlay: 1. Cost of new asset

2.Salvage value of old asset 3.increase in nwc 4.Total net investment = -(1-2 +3) II: Operating inflows over the life of the project: 5. After tax savings in manufacturing cost

6.Dep. on new machine 7.Dep. on old machine 8.Incremental dep. = 6-7 9.Tax savings on incremental dep.= 8 x 0.4 10.Net operating cash inflow= 5 + 9 III: Terminal cash inflow: 11.Net terminal value of new machine

12.Net terminal value of old machine 13. Recovery of incremental nwc.

14.Total Terminal cash inflow =11-12 + 13

IV: Net cash flow (4 + 10 + 14)

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• How Financial institutions and Planning Commission define cash flows:

• Financial institutions: • Cash outflow: = Capital expenditure on the

project (net of interest during construction) + Outlays on working capital

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• Cash inflow: = Operating Inflow (i.e. PAT + Dep.

+ int. on lease rental ) + Terminal Inflow ( i.e.

Recovery of wc at book value + residual

value of capital assets i.e. land at 100% and other capital assets at 5% on initial cost).

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• For IRR purposes, the max. life of the project would be 12 years in general and may be shorter depending upon the rate of technological obsolescence.

• There are some minor differences between the way the financial institutions define and we have defined the cash flows from the total funds point of view.

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Cash flow stream defined by the financial institutions

Cash flow defined from the total funds point of view

Initial investment Capital expenditure on the project (net of interest during construction period) + outlay on working capital

Same as in Financial institutions

Operating cash flow PAT + Dep. + INTEREST..

PAT + Dep. + INTEREST (1-T)

Terminal Cash Inflow Recovery of WC at book value +Residual value of capital assets (LAND AT 100% AND CAPITAL ASSETS AT 5% OF INITIAL COST)

Recovery of WC at book value +EXPECTED NET SALVAGE VALUE OF OTHER ASSETS

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• Planning Commission:• The “Manual for preparation of feasibility

reports” developed by the Planning Commission has prescribed certain rules in this regard.

• Interest during construction period should not be allowed for in the year wise capital expenditure figures since it is implicitly taken into account by the discounting procedure. (Any replacement expenditure incurred during the life of the project should be allowed in the year of occurrence)

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• Returns should be defined on a gross basis as operating revenues minus operating costs.

• Depreciation and financial charges on capital expenditures covered by the capital cost figures should not be deducted in defining returns.

• They are allowed for implicitly in the discounting procedure.

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• Capital cost estimates generally do not allow for funds required for wc purposes, which are assumed to be borrowed, but only for the margin on wc.

• In this case, the operating cost estimates must include interest payments on funds borrowed for working capital.

• In some cases involving the use of fixed interest term loans for capital expenditure, an IRR on own funds may need to be presented.

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• In such cases, the initial capital cost figures should cover only the expenditures out of equity capital.

• Repayment of term loans and interest due on them should be allowed for in the subsequent years as and when they are expected to arise.

• Costs and returns should be calculated over the entire life of the project or over 25 years whichever is less.

• The returns should allow for a salvage value of assets at the end of the period.

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• So the following observations are in order:• A project may be viewed from the point of

view of equity capital or long term funds.• Cost and return streams have been defined

consistently with the point of view adopted. Further they are defined in pre-tax terms.

• A fairly long planning horizon is envisaged. This perhaps reflects the fact that the projects considered by the Planning Commission, in general , have a long economic life.

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• Biases in Cash Flow estimation:• Overstatement of profitability:• Native optimism (overestimates of

themselves); Attribution error (wrong perceiving of the causes of events, taking credit for positive results and attributing failures to other causes);

• anchoring (holding on to their beliefs even if contrary evidences are available)

• Myopic euphoria ( Each person’s favourable opinion is reinforced by the opinions of others in the group);

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• Competitor neglect (neglecting the capabilities of the competitors in similar lines of business);

• Organisational pressure (every sponsor exaggerating the benefits of his project to get accommodation within the budget of the organisation);

• Stretch targets ( Managements set stretch targets for motivating their employees. Nobody likes to listen to pessimistic news even if true)

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• Tempering the optimism: • Too much of optimism is bad. Management

should look at the results of similar outside projects to arrive at reasonably optimistic targets.

• For taking an ‘outside view’ Daniel Kaheman and Amos Tversky suggest the five step procedure: Select a reference class, Assess the distribution of outcomes, Intuitively predict your project’s position in the distribution, Assess the reliability of your prediction and Correct the intuitive estimate.

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• Putting optimism in place: Daniel…. says that there needs to be a balance between optimism and realism – between goals and forecasts. Aggressive goals may motivate the people but outside view forecasts should be used to decide whether or not to make a commitment in the first place.

• Understatement of profitability: • The opposite kind of bias can occur while

forecasting the terminal cash flows and may understate the profitability and due to this some of the projects which can otherwise be accepted may be rejected.

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• For example, defining the salvage value of the assets at 5% of the initial cost: This may happen due to :

• underestimating the salvage value (actual wear and tear is much less than the depreciation provided) ;

• ignoring intangible benefits; (the project may establish a market position, create an R & D capability , enhance distribution network, and build brand loyalty);

• and Value of future options is overlooked (new investment opportunities are opened up through this project).

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9.Materials Management in Project Planning-Procurement, storage and

disposal • Different varieties of quality materials have to

be procured in adequate quantities at the right price, stored safely in a proper place , used judiciously during the execution of the project and the waste if any have to be disposed efficiently.

• Here are some ‘right’ parameters about the material required for the project:

right price; right quality and right technology;………

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Procurement Planning

• ……..right engineering parameters; right lead time; right quantity; right source; right packaging; right transportation; right handling methods; right insurance; right legal contracts; right place of delivery; right ethical standards;

• According the PMBOK: “Project procurement Management is a process of acquiring goods and services from a firm external to the performing organisation.”

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Procurement Planning

• There are seven key components in a project procurement management system :1.project procurement planning, 2.solicitation planning, 3.solicitation, 4.source selection, 5.contracting, 6.contract administration and 7.contract closing.

• 1. Project procurement planning: It is the process of discovering the needs of the project that can be satisfied by acquiring products and services from firms external to the project organisation.

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Procurement Planning

• It involves the questions: What to procure and then how and when?

• Centralised procurement process has its advantages of cost savings.

• The organisation may have policies to procure all materials from a single or multiple suppliers.

• Before this process begins, some documents relating to the project would exist and they can be taken as guide:

• They are Scope statement,. Product or service description/ PBS, procurement sources, market conditions, make or buy analysis.

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• The project manager usually resorts to the CPM and PERT techniques to estimate the timings of the products or services to be procured.

• So defining the needs of the project is the most crucial task of the Project manager.

• The product or service description provides information pertaining to the technical specifications of the products which are to be kept in mind while procuring.

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Procurement Planning

• Though the content and format of a product or service description statement vary from product to product and from project to project, it must be elaborate enough to support the latter stages of project planning.

Usually product or service specifications are written or graphical representations consisting of:

Design specifications (the physical characteristics of the product),

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Procurement Planning

performance specifications ( the required operational capabilities of the end product)

and functional specifications (part of the performance specifications and identified only when the vendor mentions the utility of the product or service).

Procurement resources: Description of the resources –systems and personnel- needed to procure the products and services from the market as per the specifications given in the product.

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Procurement Planning

• If the project is complex, then the presence of a specialised procurement team is necessary so as to properly communicate to the suppliers of the critical supplies and procure them at the right time.

Market conditions: The purchase manager should be well conversant with the market – products available in the market, terms of the vendors, inflation rates, interest rates , ordering costs and the WBS etc.

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Make or buy analysis: When the Project Manager is armed with the required info on the required product and the market conditions, he has to decide whether to procure them from within the organisation or from outside.

Making the product/s within the organisation has its advantages of control on quality, delivery schedule, and savings on costs.

But if that is not possible, it is better to procure the material from the appropriate vendors.

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Such ‘Make or Buy’ decisions should be taken after considering the direct as well as indirect costs (ordering cost, transportation cost etc.), the organisation’s point of view and also the timeliness of the needs of the project.

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Reasons for Making:

1. Lower Production Costs;

2. Unreliable suppliers;

3. Assurance of supply of adequate quantity;

4. Utilisation of surplus labour capacity;

5. Quality Control

and

1. Protection of special design or quality

(Copyrights/Patents)

Reasons for buying:

1. Inadequate capacity in own manufacturing;

2. Reduction of inventory costs (JIT);

3. Ensuring alternate sources of supply;

and

4. Easy availability of standardised materials

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Procurement….

Expert judgement: Analysis of the procurement process can be done by the specialists if available in the firm, or by the consulting firms or by the professional, technical associations conversant with the products.

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Selection of vendors

• In the process of selection of the vendor, the vendor and the project manager try to pass on the risks to the other, at he same time expecting good performance.

• The contracts that the project manager would enter with the vendor may be of different types such as :

• Fixed Price (FP) contracts: - the price is negotiated by the vendor and the project manager and agreed upon a fixed price;

- the vendor has to absorb any losses or profits due to subsequent increase or decrease in prices;

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Selection of vendors

- --the process may be time consuming since the vendor may take more time to assess the risks over the contract period to arrive at the price profitable to him;

- the vendor may even inflate the price in anticipation of future increase in costs;

• Cost plus Fixed Fee (CPFF) or cost plus percentage fee: In this type of contract, the project bears all the costs of the product or service and the vendor is paid a fixed fee for supplying the goods.

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• --In this type of contract, the risk is with the project manager and not the vendor. (example is a building contract, where the owner of the plot bears the costs of all materials and the labour and the vendor is paid a percentage of commission);

--the project manager is not assured of the final cost; there is no reward for the vendor if time and cost are saved..

• Guaranteed maximum and shared savings (GMSS) contracts:

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Selection of vendors

--The vendor is not selected by tender and has to complete the contract within the ‘guaranteed maximum’ amount.

--If the cost exceeds this ‘guaranteed maximum’, it is for the vendor to make up and the savings if any, (i.e. ‘maximum’ minus the actual cost) is shared by the vendor and the project.

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Selection of vendors

--In this type, the cost to the project is limited by a definite amount.

--Price negotiation has to be done carefully in order to avoid the inflation of the ‘guaranteed maximum’ amount.

• Fixed price incentive fee (FPIF) contracts”: --This is similar to the FP with the difference

that if the vendor is able to minimise the costs, then the saving is shared by the project and the vendor.

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Selection of vendors

• Cost plus incentive fee (CPIF) : --This is similar to the CPFF except for the

flexibility of altering the fee based on a formula which compares the total project costs with target costs.

--Usually organisations handling R & D type of projects enter into these types of contracts and the vendors are the maximum risk takers.

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Selection of vendors

• It is necessary for the top management and the project manager to plan procurement management very carefully and prepare the procurement management plan and statement of the work.

• The factors influencing the selection of the contract method are : Degree of risk involved in terms of cost and time; nature and technical risk involved; degree of competitive dynamics in pricing; evaluating the price of the product or service;……

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Selection of vendors

…… level of exigency of the requirement; the vendor’s risk absorption capacity; and his financial management system consistency of the vendor’s commitment to the project.

• The Procurement Management Plan: Is the document detailing how the processes would be managed from solicitation planning till closing the contracts:

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Selection of vendors

• the type of contracts, the persons in charge for developing the estimates for evaluation purposes, managing multiple vendors, combining the procurement activities with scheduling etc.

• Statement of work: A detailed, precise and transparent description of the product or service to be procured for the vendor to decide on his capabilities to take up the assignment.

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Selection of vendors

• The details will vary depending upon the nature of the product or service of type of contract.

• The statement may be periodically revised by rephrased depending on the ongoing interactions with the vendor.

• Procurement Document: This is a document that is used to invite proposals from the eligible vendors.

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Selection of vendors

• Generally the words bid and quotation are used when the product or service to be procured is price sensitive and much sophisticated.

• The word proposal is used when non financial aspects like technical skills is in focus and is used while inviting architects and consultants.

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Selection of vendors

• A typical RFP cover many topics such as: A brief overview of the project, product specifications, mode of supply of products/services, mode and time of payment, insurance of the product/services, names of the key people with authority and responsibility to take decisions etc.

• The format should be designed in such a way that it elicits in-depth, accurate and complete information from the vendor.

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Selection of vendors

• Criteria for judging the vendor: Some of the factors are:

Total cost of procurement; vendor’s capacity to deliver at lowest cost; technical expertise, management style, and financial position.

• Solicitation: The next stage is solicitation. It is the process of obtaining quotations, bids, offers or proposals from all the prospective vendors. This involves:

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Selection of vendors

short-listing the vendors : The list should contain all the info about their expertise in different functional areas.

If not readily available from sources like associations, then meeting with customers of the vendors, visiting their sites, enquiring from their bankers etc.

meetings with the vendors: These meeting precede the proposals from the vendors and are used to eliminate all the communication gaps regarding the needs of the project and prepare the ground for further negotiations.

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Selection of vendors

The negotiating team may comprise of experts from all the relevant functional departments.

When consensus is arrived at on all the relevant issues, both the sides sign the written contract incorporating the terms and conditions.

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Selection of vendors

Advertising: This is a tool used by the project organisation to invite proposals from vendors through sealed bids.

There is no negotiation of price and the lowest bid is usually accepted.

Advantage of advertising is that a data base of potential vendors can be created from the responses received for the advertisement.

For the projects involving the government, advertising in mass media is mandatory.

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Selection of vendors

• Vendor Selection: This is the process of receiving proposals from prospective vendors and evaluating these proposals to choose the right vendor. The proposals are classified into technical and commercial and both are evaluated separately in each and every proposal. The tools used for selecting a vendor are:

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Selection of vendors

• Contract negotiation: • Is a process aimed at enhancing the clarity

and ensuring mutual consensus on the structural and procurement aspects mentioned in the contract, before signing it.

• The topics to be covered in the contract are: price of procurement, technical approach, management style, terms and conditions, legal bindings etc.

• The contract may be in the form of a MOU in the case of highly complex and technical products.

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Selection of vendors

• Weighing system: Is a process in which all the info pertaining to the qualitative aspects of the vendor is quantified.

• It involves identifying and scoring all the significant activities from the proposal, setting up a range for qualifying them based on the significance level and weighing them against the total scores.

• Screening system: Is a process of establishing basic performance standards for qualifying the proposals and the vendors have to qualify in the performance specification test developed by the screening system.

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Selection of vendors

• Developing independent estimates: This process is aimed at checking the authenticity of the price quoted by the vendor.

• The project organisation develops its own estimations of product pricing.

• Any gap between the vendor’s and vendee’s price estimates indicates that the data in the statement of work is insufficient or the vendor failed to correctly interpret the statement of work.

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Contracting….

• Contracting: After selecting the vendors and evaluating their quality thoroughly, the project organisation has to sign contracts with the vendors to bind them legally to deliver the specified product.

The project organisation is also responsible for paying the vendor the agreed price on the successful completion of delivery.

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Contracting….

• In general, the contract should contain: the definitions of

• vendor, vendee; • responsibilities of the vendor and vendee; • the type of contract being administered and

the mode of payment; • the process of change requisition and its

approval; • vendor’s warranty/guarantee for the product;• terms and conditions of closing the contract

and consequences for deviating from the agreement like late delivery etc.

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How to order materials?• 1) Electronic Ordering (Transactions Between Firms

via Electronic Data Interchange –EDI; Involves standardized Data Transmittal Format through Computers; Reduces Paper Transactions; Speeds Up The Procurement Time.)

• 2) Stockless Purchasing (Arrangement in which a supplier holds the items ordered by the customer in its own warehouse, and releases them as and when required by the customer)

• 3) Just in Time Purchasing (JIT originated in Japan & is generally associated with the Toyota motor company - JIT purchasing is directed towards the reduction of waste i.e. excess inventory and delay such that items only move through the production system as and when they are needed)

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Points to be kept in mind..

By the Project Manager while procuring materials:• Price Volatility• Timely Availability• Limited Storage Space

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Contract administration

• Contract Administration: according to PMBOK, Contract Administration is the process of making sure that the vendor’s performance satisfies the project needs mentioned in the contract.

• If there are many vendors, then they should all be handled.

• In short, contract administration is about applying the project management practices to the vendor-vendee relationship integrating the results of these practices back into the project.

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Contract administration

• The project management practices that are built into the contract are :

Project planning and implementation – to check whether the vendor is progressing as per the schedule;

Progress reporting : to check the vendor’s performance in terms of cost, time and technical aspects;

Quality management : to check and constantly monitor the quality of the product being produced;

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Contract administration

Change management : to check the approval and implementation of potential changes and communicating the incorporated changes to the people requiring it;

Financial management : to ensure timely and periodic payments as agreed to in the contract.

• It will be advisable for the project manager to appoint a ‘contract administrator’ to manage the total contract administration activities.

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Contract administration

• So, the duties of a contract administrator can be derived as follows:

Managing change; Ensuring that the vendor understands

specifications completely; Ensuring conformance to quality; Managing warranty on the products being

produced; Managing the sub-contractors under the

vendors;

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Contract administration

Monitoring the manufacturing process; Handling deviations from the contract; Resolving conflicts; Managing payment schedules and contract

terminations.• Job status: The info collected during the

project planning and implementation about the jobs entrusted to the vendors –completed, in process, their quality, the expenditure incurred etc. gives the picture about the job status.

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Contract administration

• Requisition for change: Any changes to be made to the terms and conditions of the contract or to the product or service specifications are covered in the statement for change request.

• Any performance of the vendor which is not upto the mark may also be taken as a change.

• But any disagreement between the vendor and the project manager on accepting the change can lead to conflicts and claims and have to be resolved.

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Contract administration

• Vendor billing process: The vendor should submit the bills at periodic intervals as per the terms of the contract along with the supporting documents for payments by the project manager.

• Contract Closing: Is a process involving verification of the product along with updating all the project documents with the final results and storing all project info for future retrieval.

• This process may also form part of the contract.

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Contract administration

• The process involves the following four steps:

• Contract documentation – copy of contract, changes requisitions, approvals vendor performance reports, invoices and payment records, contract related audits and inspections……;

• Procurement audit : formal review of procurement process;

• Contract files : total set of indexed documents developed to include it in the final project records;

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Contract administration

• Formal acceptance and closing: process wherein the contract administrator submits a formal written notice to the vendor saying that the contract is complete.

• The contract administration may have the authority (as per the contract terms) to decide to close a contract at any time.

• If at the time of closing the contract, the vendor has already incurred some expenditure on the project, the project manager may have to compensate the vendor up to a certain amount as per the terms of the contract.

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Contract administration

• The possible reasons for the project administration to close the contract are:– The product that was being procured is

not required any more;– Technological advancement that can by-

pass the product requirement;– Change in the allocation of funds;– Availability of substitute products;– Lack of profit expectancy;– Failure to supply the product or service as

per the schedule;

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Contract administration

--Lack of progress in the activities of the contract;

--Failure to stick to the terms and conditions of the contract – deviation from the contract in terms of quality and performance standards.

• If there is a breach of contract on the part of the vendor, the project administration may not pay the vendor or even recover the advance amount if given earlier.

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Contract administration

• If the contract is terminated, the contract administrator has to check the breach of contract and then decide to accept, partially accept or reject the products/services supplied by the vendor.

• He may then wait for some time to see if the end products/services supplied by the project are returned for rectification and if so determine the monetary value of the penalty to be charged to the vendor before finally settling his account.

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Contract administration

• Thus, terminating a contract is one of the challenging tasks of the contract administrator.

• Project Inventory: The project materials occupy a sizeable chunk of the total materials required for a project.

• If the inventory is not properly handled, it may result in shortage when needed and may be available in plenty at other time, occupying lot of space and precious working capital.

• This will result in time and cost overruns.

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Project Stores Management

• Therefore the requirement of inventory should be continuously monitored and managed.

• “JIT”, the Just in Time strategy may be used by the project to save in inventory holding costs.

• Project Spares: Usually the OEMs provide the list of recommended spare parts as well as mandatory spare parts, which mostly the project managers procure.

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Project Stores Management

• Among all the areas of Project management, the warehousing of the project material appears to be the most neglected, even though a major chunk of the project investment is in the material.

• In India, it is a common sight to see the project machinery being stored in open grounds gathering dust and rust till they are properly erected.

• The responsibility of the stores manager is an efficient, smooth running, economic operation of the stores to give good timely service to the project.

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Project Stores Management

• Obviously the stores manager requires adequate space to store the materials and a group of competent staff to handle them.

• The ill-effects of bad stores management: Materials like cement or paint would harden;

• Iron and steel items would corrode;• electronic instruments would be spoiled due to

humidity, heat and dust; • fluids like petrol evaporate; • materials containing wood get damaged by

white ants;

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Project Stores Management

• storage batteries getting damaged due to humidity;

• Glass sheets stacked one over another exposed to the sun crack;

• fire bricks disintegrate due to water;• materials containing cloth and paper being

eaten away by rats and cockroaches• and the list can go longer.

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Project Stores Management

• Thus the stores manager has to guard the project materials from light, sun’s rays, air, heat, moisture, water, oils, dust, dirt, rats, moths, white ants, fire, explosions, theft and pilferages.

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Financing of the project

• A project may entail investment in : land, plant and machinery, other fixed assets, technical know-how, royalty, advertisements, distribution network and working capital.

• So, just like any corporate needs finance for its various activities and plans the appropriate structure of finance from various sources, the project manager has also to do the same exercise.

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Financing of the project

• So the questions that arise are: What is the total cost of the project? What should be capital structure? Which financing

instruments? Whether the sources should be internal or external? If external, whether it should be private or public

sources? What should be the ideal cost of capital? How much should be from short term and how much

from long term? etc.

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Financing of the project

• Preliminary and capital issue expenses;• Pre-operative expenses;• Margin money for working capital and • Initial cash losses.

• The Means of Finance are as follows:– Share Capital/reserves;– Preference Capital;– Private Equities/Venture Capital;– Term Loans;

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Financing of the project

• Cost of the project comprises of the outlay on account of:

• Land and site development;• Buildings and Civil works;• Plant and machinery;• Technical know-how and engineering

fees;• Expenses on foreign technicians and

training of Indian technicians abroad;• Miscellaneous fixed assets;

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Sources of Finance

– Debentures;– Deferred credits (from suppliers of plant

and machinery);– Incentives and – Other Miscellaneous sources (Unsecured

loans, public deposits, leasing and hire purchase finance).

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Sources of Finance

• Planning the means of finance: The norms prescribed by the regulatory bodies and the financial institutions and the key business considerations of the project sponsor have to be kept in mind while planning the structure of the means of finance.

• The norms of the regulatory bodies have the interest of the investors as one of the objectives.

• The norms of the financial institutions have the safe return of their funds with interest as their objective.

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Sources of Finance

• The project sponsor will have the following factors in mind: – cost of funds –cost of debt is cheaper due

to tax rebates on interest paid, whereas dividend tax has to be paid on the dividends paid out;

– Risk: Business risk arises from the variability of earnings and the financial risk arises from financial leverage i.e. amount of debt;

– Control: the sponsors would like to have a programme of financing which enables to retain their control over the firm;

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Sources of Finance

– Flexibility: the structure of finance should be such that the firm is able to borrow or raise further capital in future if necessary.

• While discussing the capital structure it is worthwhile to study the pluses and minuses of equity and debt by comparing them:

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Equity Debt

Equity shareholders have a residual claim on the

income and wealth of the firm.

Creditors have a fixed claim in the form of interest and principal payment.

Dividends paid is not tax deductible

Interest paid by the firm is tax deductible

Equity has an indefinite life Debt has a fixed maturity

Equity investors have the right to control the affairs

of the firm

Debt investors play passive role – apart from imposing restrictions on the way the firm is run, to protect their interest

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Sources of Finance

• Thus, Equity is costlier but less risky, whereas the debt is cheaper but more risky.

• In general, for tangible assets, debt finance is used (since the lenders’ comfort level is more with the tangible assets) whereas for intangibles, equity finance is preferred.

• Business Risk: - the variability of earning power (=PBIT/total assets).

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Sources of Finance

• The factors that bring to bear business risk are: Demand variability, price variability, variability of input prices, and proportion of fixed operating costs.

• The higher these variabilities and higher the fixed cost, the higher is the business risk that the firm would face.

• As a general rule, the combined business risk and the financial risk should be manageable.

• A firm which facing more business risk should try to reduce its financial risk and vice versa.

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Sources of Finance

• Debt Equity norm of lenders: Lenders normally permit the Debt/Equity norms up to 1:1 but permit higher ratios up to 2.33:1 for capital intensive infrastructure projects like power projects.

• Control considerations: Promoters who want to retain control over the affairs of the firm should have high proportion of equity.

• Market conditions: If the equity market is active and buoyant, then the firm may get a good premium for it’s equity issues whereas if the market is depressed, the firm may go in for more debt.

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Sources of Finance

• Growth opportunities: When the firm has good growth opportunities, the firm should go for more equity whereas a firm which does not have much growth opportunity should go for debt.

• Public and private sources of capital: Debt as well as equity can both be raised from public (securities offered to public through ‘offer documents’ filed with the SEBI and made available through secondary markets)…………

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Sources of Finance

• ……as well as private sources (loans given by banks, financial institutions, or issue of equity/preference shares, debentures privately placed with PE funds, VC firms, FIs, Insurance cos., MFs, and HNIs.)

• Internal accruals: The internal accruals consist of the non-cash charges like depreciation and the retaining earnings.

• Retained earning is the (PAT minus the preference and equity dividend minus dividend tax paid.), which is ploughed back in the firm.

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Advantages of Internal Accruals

Disadvantages of Internal Accruals

Readily available to the management for

use

The available amount may be limited

Eliminates issue costs and losses on

account of under-pricing

The opportunity cost of the retained earnings is very high

No dilution of control Opportunity cost of depreciation generated funds is the WACC.

Firms may underestimate the opportunity cost of dep. Funds and the retained earnings and accordingly they may invest in projects of low return leading to destruction of shareholders’ wealth.

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Sources of Finance

• Equity Capital: This is the capital collectively owned by all the equity shareholders.

• They rank as the last claimants to the assets of the firm and their liability is limited to the extent of their shareholdings.

• In India, equity shares have a ‘par value’ – may be Re.1, Rs.2,4,5,10,20,50,100 or 1000 or it may be any integer.

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Sources of Finance

• Even in the case of IPO (Initial Public Offering –the first Public Issue of the Co.) or any FPO (Follow on Public Issue – which are subsequent Public Issues ), the shares may be priced above the par value i.e. at premium as per the advice of the Investment bankers to the issue.

• In India, shares cannot be issued at discount to the par values.

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Sources of Finance

• The equity shareholders have a right to income from their investments, right to appoint the Board of Director, have a right for additional shares proportionate to their existing holdings and the residual claims on the assets of the firm on liquidation.

• However in reality, if a company has to be liquidated, the equity shareholders may not get anything.

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Sources of Finance

• In India, it has been observed that the shareholders are indifferent and do not exercise their power effectively, resulting in the promoters holding the reins of control, even if their holdings in the co. may not be substantial.

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The advantages and disadvantages of the equity capital are:

Advantages Disadvantages

No legal consequences of skipping dividends. So

the co. need not pay dividends if there are no

sufficient earnings or when the profit is

required to be ploughed back due to good

investment opportunities

Sale of equity dilutes the control of the existing shareholders

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No maturity date and hence the co. need not

redeem them

Rate of return required by the equity investors is generally very much higher than the requirement of the other investors

The larger the equity, the larger is the

capacity of the firm to raise debt finance

Dividends are paid out of PAT, whereas interest payments are tax deductible

Equity dividends are exempt from income

tax at the hands of the equity shareholders

Cost of issuing equity is high due to underwriting commission, brokerage costs

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Sources of Finance

• Preference capital: - a hybrid instrument having some characteristics of equity and some of the debentures.

• Preference dividends are payable only out of distributable profits but paid before the equity shareholders are paid.

• The Preference dividend is not a tax deductible payment for the company.

• Usually the preference dividend amount is fixed and much lower than the rate of dividend paid to the equity holders.

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Sources of Finance

• Preference equity holders do not have the right to vote and their residual claim ranks above the equity shareholders.

• There are different types of preference shares: ● Cumulative and non-cumulative preference shares, ● participating and non-participating preference shares, ● redeemable and non-redeemable preference shares, and ● convertible and non-convertible preference shares. (In India, issue of Non-redeemable preference shares is not permitted).

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Advantages and disadvantages of preference capital:

Advantages Disadvantages

No legal obligation to pay

dividends.

Since dividends paid to preference share holders is not tax exempt, it is costlier than debt

No redemption liability in the case of non-redeemable preference

shares

Preference share holders’ claim to the assets of the co. are prior to the claims of the equity share holders.

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Considered part of net worth if redemption is subordinated to debts

If the co. skips preference dividends for three years, voting rights have to be given to the preference share holders

No voting rights and hence no dilution of

control

Advantages and disadvantages of preference capital……..

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Sources of Finance

• Debentures: Debenture is an alternative to term loan. The Co. promises the debenture holder to pay interest periodically at the indicated rate and redeem the debenture on the maturity date.

• The features of debentures are:– A Trustee, usually a bank or a financial

institution or an insurance company is appointed to take care of the interests of the debenture holders to see that the co. fulfils its contractual obligations.

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Sources of Finance

– Secured debentures are secured by mortgages or charge on the immovable properties and a floating charge on the other assets. Debentures may also be unsecured.

– These are medium term (1 to 5 years) or long term (more than 5 years) instruments

– Debentures for periods 18 months or above have to be compulsorily rated

– For debentures of over 18 months DRR has to be created and built up to at least 50% before the redemption date.

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Sources of Finance

– They may carry fixed or floating rate of interest (linked to a benchmark such as the treasury bill) (or zero interest in the case of deep discount bonds)

– They may have in-built features of ‘call’ and ‘put’ options in favour of the issuers.

– The interest paid on the debentures is a tax deductible expense for the co.

– Debentures may be issued with the feature of partial or full conversion facility at the end of a certain predetermined period.

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Sources of Finance

– (Part or full amount of the Debentures are converted into shares at the predetermined premium)

– Convertible debentures are generally popular since the interest payable on them is lower than non-convertible debentures and also lower than the bank interest the co. would have paid for a bank loan, and enables the co. to convert the debenture amount into shares at premium.

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Sources of Finance

Secured Premium Notes (SPNs): This is a new instrument introduced by TISCO in 1992.

• This is akin to a debenture with the interest payments staggered and paid along with part of the principal, in four instalments at the end of the 4th to 7th years. (FV Rs. 300. Repayments at the end of 4th year to 7th year : Rs. 75 towards principal + Rs. 75 towards interest and a warrant of entitlement of one share at Rs. 80 at the end of the 7th year.)

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Sources of Finance

• Indexed bonds: ICICI issued such bonds in 1997, each for Rs. 6000:

• It contained two parts – one was a deep discount bond with redemption value of Rs. 22000/- at the end of 12 years.

• The second part was a small amount of Rs. 2000 the amount of repayment being calculated as 2000*BSE sensex2000/BSE Sensex1997.

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The advantages and disadvantages of debt financing are:

Advantages Disadvantages

Interest paid on debt is tax deductible expense whereas dividends paid on equity or preference

shares are paid out of PAT

Failure to make the timely interest and principal repayments may cause bankruptcy of the firm

Does not result in dilution of control

Increases financial leverage and hence according to CAPM increases the cost of equity

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Creditors entitled only to the interest and

principal and not to the value created out of the

debt

Debt covenants impose restrictions limiting the firm’s financial and operating flexibility.

If there is a significant decline in the value of

the firm, the shareholders may

default on debt and transfer the firm to the

creditors

If the rates of inflation falls, then the cost of debt would prove to be higher than expected

The advantages and disadvantages of debt financing are……:

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Issue cost of debt is very much cheaper than that of

equity/preference issues

Since interest is fixed in nominal terms, it protects the firm against

high inflation

Maturity of a debt instrument can be adjusted to the needs of the

firm

The advantages and disadvantages of debt financing are……:

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Sources of Finance

• Methods of offering: IPO/FPO/Bonds/Rights Issues/Private Placements/Preferential allotments.

• Private placement and preferential allotments involve sale of securities to a limited number of sophisticated investors like FIs, MFs, VC funds, banks and so on.

• In a preferential allotment, the identity of the investors is known when the co. approaches the share holders for approval., whereas in the case of Private placements, the identity of the investors is not known when the offer document is prepared.

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Sources of Finance

• In India Private placement refers to allotment of securities of a listed or unlisted co. Preferential allotment refers to allotment of securities of a listed co.

• Pvt. Placements do not require registration with SEBI.

• A ‘Private Placement Memorandum’ is prepared in place of the prospectus. In place of road shows, the company hosts potential investors’ meet and gives presentation.

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Sources of Finance

• Generally preferential allotment is made to promoters, strategic investors, VCs, FIs and suppliers.

• The rationale for preferential allotment is to secure the equity participation of those the company considers desirable, but who may otherwise find it very costly or impractical to buy large chunks of shares in the market.

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Comparison of the various methods of offering with each other:

Public Issue

Rights Issue

Pvt. Placement

Preferential allotment

Amt. that can be raised

Large Moderate

Moderate

Moderate

Cost of issue High Negligible

Negligible

Negligible

Dilution of control Yes No Yes Depends

Degree of under pricing

Large Irrelevant

Small No

Market perception Negative

Neutral Neutral Neutral

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Sources of Finance

• Term Loans: These are used to finance acquisition of fixed assets and working capital margin.

• Banks and FIs give rupee terms loans as well as foreign currency term loans, for the purpose of setting up new projects, or expansion, modernisation or renovation of existing of units.

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Sources of Finance

• FC loans are used for the import of plant, machinery and equipment, payment of foreign technical know-how fees etc.

• Repayment liability of principal and interest remains in FC and converted into rupees at the time of payment at the then ruling rates.

• The assets that are created out of the loan form the main security for the loans and any other securities may form the collateral securities.

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Sources of Finance

• Usually, the term lending FIs which finance the acquisition of fixed assets and the banks which finance the working capital requirements are in constant touch with each other and coordinate the lending activities, while monitoring the accounts of the borrower.

• The FIs have the ‘first charge’ over the assets which they have financed and have the ‘second charge’ over the assets financed by the banks.

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Sources of Finance

• The banks have the first charge on the assets they finance and have the second charge on the assets financed by the FIs.

• Thus all the assets of the firm are charged to the lenders.

• There are three types of term lending institutions:

• All India FIs: IFCI, EXIM Bank, IL&FS, PFC, IDBI, IDFC,IIFCL, SIDBI, LIC, GIC. IDBI and ICICI were in this category but have been converted into banks.

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Sources of Finance

• State Level FCs: SIDCs and SFCs.• Commercial Banks.: These banks do not

extend term loans for periods beyond 5-8 years normally, since their focus is on short and medium terms.

• For term loans, the lenders also charge a “processing fee’ of about 1% of the loan amount.

• There may be an initial repayment holiday, till the project starts commercial production .

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Sources of Finance

• Thereafter the repayments of the principal and interest due would begin at monthly, quarterly or half yearly intervals depending on the cash flows projected.

• Since the lending institutions will charge penal interest on the ‘overdue’ amounts (i.e. the amounts of principal and or interest not paid on due dates), the project manager has to correctly calculate the cash outflows on account of these dues.

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Sources of Finance

Usually the loan documents stipulate certain covenants such as:

the board should have a nominee from the lenders,

additional funds should be brought in by the promoters in case of overrun;

bar to undertake any new project until the dues are paid in full;

restrictions on transfer of shares of promoters to others,

payment of dividends with the permission of lenders etc.

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Sources of Finance

Procedure of sanction of term loan by the FIs/banks:

Application by the co. in the lending institution’s standard form along with the necessary enclosures like the Project Report,

Projected financial statements etc; Initial processing by FI to check whether the

application is complete; appraisal of the project;

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01/01/2010 593

Sources of Finance

Procedure of sanction of term loan by the FIs/banks:

Application by the co. in the lending institution’s standard form along with the necessary enclosures like the Project Report, Projected financial statements etc;

Initial processing by FI to check whether the application is complete;

appraisal of the project; Sanction of the proposal by the appropriate

authority and issue of the Sanction letter to the co. along with the detailed list of terms and conditions/covenants;

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Sources of Finance

creation of charges in favour of the lenders; disbursement of the loans in stages as agreed

between the lenders and the co. depending upon the projected cash flows;

and monitoring of the progress of the project and recovery of the interest and principal.

• Depending on the size of the loan, more than one bank/institution may participate in the lending with a view to share the risk.

In such a case, the co. appoints one bank as the ‘lead bank’ , and prepares an ‘Information Memorandum’.

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Sources of Finance

The lead bank enlists the services of some other banks in sharing the lending based on the Information Memorandum.

This process is known as ‘Syndication’ • Working Capital Advances: Used for financing

the current assets. • In the pre-production stage, finance is given in

the form of Cash Credit/Overdraft/Letter of Credit.

• Under the Cash Credit/Overdraft system, the bank fixes the maximum amount that the co. can draw for its operations, called the ‘limit’.

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Sources of Finance

• Interest is charged periodically on the actual amount utilised by the co.

• The operations are reviewed at the end of every year and then renewed for another year.

• In the case of loans, the limit amount assessed for working capital needs of the co. is given in the form of a loan and interest is charged on the entire loan amount till it is repaid.

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Sources of Finance

• In some cases, the supplier of RM may demand an LC in which case the bank gives the LC facility also to the co. as part of the WC limits.

• LC is opened in favour of the supplier of the RM, and on receipt of the stipulated documents form the supplier, the bank pays the supplier.

• The amount is then recovered by the bank from the co.

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Sources of Finance

• In the post production stage, the co. sells its products, raises bills on its customers, some of whom avail some credit periods for repayment.

• The bank discounts such bills on the co.’s debtors and credits the amount to the Cash Credit/Overdraft account. Thus the cycle goes on.

• There are other miscellaneous sources of finance and they are:

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Sources of Finance

• Deferred credit: Suppliers of capital goods usually offer long term credits.

• If the rate of interest loaded in the price is less than the bank’s rate, it would be advantageous for the co. to avail the deferred credit.

• However the supplier extending such deferred credit is subject to a bank guarantee, which would be part of the credit facilities extended by the bank to the co.;

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Sources of Finance

• Lease and Hire Purchase finance; A Lease finance represents a contractual arrangement whereby the lessor grants the lessee the right to use an asset in return for periodic lease rental payments.

• Leasing of industrial equipments is a form of debt finance. Two types of leases: Financial and Operating leases:

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The differences between Leasing and Hire Purchase is tabulated below:

Leasing Hire Purchasing

Lessee cannot claim depreciation

Hirer is entitled to claim depreciation

The entire lease rental is a tax-deductible

expense for the lessee

Only the interest component of the hire purchase instalment is a tax-deductible expense

The lessee not being the owner does not get

the benefit of the salvage value of the

asset

The hirer being the owner of the asset, gets the benefit of the salvage value of the asset

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Sources of Finance

• Unsecured loans and deposits: These are the loans provided by the promoters themselves or their friends and relatives to make up the shortfall of the required promoters’ stipulated contribution.

• These loans usually carry a rate of interest lower than those on loans from the FIs, cannot be repaid without the permission of the FIs and till their loans are cleared.

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Sources of Finance

• Some well known companies prefer to collect deposits from the public for periods depending on their cash in flow, since the covenants that apply to loans from FIs do not apply.

• However new companies may not be able to raise such deposits since their track record is yet to be built to attract the attention and confidence of the public.

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Sources of Finance

• Special schemes of institutions: Sellers of Capital equipments offer long term credits to their buyers by obtaining their accepted Bills of exchanges, discount them with their bankers who in turn rediscount them with IDBI to refinance themselves.

• ICICI operates a “Suppliers’ Credit” Scheme, where the bank discounts the long term Bills of exchanges of the sellers after they are accepted by the buyers and co-accepted (‘avalised’) by their bankers.

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01/01/2010 605

Sources of Finance

• Subsidies and sales tax deferments and exemptions: Some states offer subsidies to projects located in their states by giving them a sizeable amount of the project cost say even upto 25% subject to a certain maximum amount.

• In addition some states offer sales tax exemptions (on materials purchased from the state) and deferments for a few years.

• The deferments are equivalent to interest free loans.

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Sources of Finance

• Short term loans from financial institutions : Companies with good financial track records are offered short term – one year—loans without any securities for tiding over their financial difficulties. These are called ‘Corporate loans’.

• Commercial papers: Companies with good credit rating may issue CPs which are unsecured promissory notes for periods not more than six months.

• These are sold at discounts to the face values and redeemed at their face values, the discount representing the interest on the CPs. (See RBI’s website for the latest guidelines :http://www.rbi.org.in/scripts/BS_ViewMasterCirculars.aspx?Id=4285&Mode=0)

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Sources of Finance

• Factoring: ‘Factors’ are FIs which extend finance upto 80% of the receivables of their customers and also manage the receivables.

• SBI Factors, Can Factors, PNB Factors and Allahabad Factors have been authorised by RBI to serve the western, southern, northern and eastern parts of India.

• Securitisation: It is a method adopted to liquefy the assets of a firm which has got receivables.

• The assets are bundled, rated and then securities are issued to the investors giving them the bundle of securities as collateral securities.

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Sources of Finance

• The pool of securities are normally transferred to an SPV which holds the securities in trust for the investors for which service, the SPV is entitled for an appropriate fee.

• The securities are called Pass Through Certificates (PTCs).

• The pool may be divided into different classes depending on their rating and the PTCs may be issued against each distinct rated class of securities.

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Sources of Finance

• Obviously the PTCs issued against the best rated securities will carry the least rate of interest and will be redeemed first.

• Raising Venture Capital: If a co. which is not yet known to the public cannot approach them with the offer of a Public Issue to raise finance for its needs.

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Sources of Finance

• The Venture Capitalists (VCs) study the entrepreneur’s and his business’s potential to satisfy themselves that the entrepreneur’s management team is capable, talented, experienced, committed and determined and then invest in the co.

• After a few years, the VCs exit the co. by divesting through ‘Offers’ to retail investors at premium or to other entrepreneurs with a good margin of profit.

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Sources of Finance

• Raising Capital in the international markets: Due to the globalisation of the Capital markets, an Indian entrepreneur can now approach off-shore markets, or markets in other countries for raising capital (ADRs, GDRs) or borrowing (syndicated loans) or issue bonds (FRNs, RUFs) in any currency.

• The RBI has issued detailed guidelines about the External Commercial Borrowings (ECBs) --about the eligibility of the borrowers, limits of borrowing, maximum rate of interest outflow etc., .Look up for the same in their website: http://www.rbi.org.in/scripts/BS_ViewMasterCirculars.aspx .

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Sources of Finance

• Evaluation of overseas debts: Overseas debt, especially the Eurocurrency loans offers the following advantages:– Participating institutions have a very

professional approach and have huge funds at their disposal to give loans of any amounts;

– A lot of flexibility is availability in structuring the loans;

– Tenors of the loans may go even up to 10 years;

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Sources of Finance

• The disadvantages are :--ECBs are not economical for small projects due

to costs involved for appraisal and syndication;– Interest rates charged depends on the risk

perception of the lender/lead lender;– May be difficult to negotiate with the investors.

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Sources of Finance

• Global Deposit Receipts (GDRs) : These are indirect equity investments issued in $s in the Euromarkets.

• The shares issued by the co. are held by a depository, usually a large international bank which receives all the benefits of the underlying shares and distributes to the holders of the DRs.

• Each DR represents a certain number of shares. These GDRs are listed and traded in major stock exchanges in Europe.

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Sources of Finance

• The issuer pays dividends in the home currency to the Depository which is converted into $s and paid by the Depository to the holders.

• The holders of the GDRs can convert the DRs into shares at any time by surrendering them to the Depository.

• Since GDRs are FDIs, appropriate permission has to be obtained from the FIPB and RBI.

• American Depository Receipts (ADRs): ADRs are similar to the GDRs except for the fact that they are listed in the Stock Exchanges in the USA and attract more stringent disclosure conditions imposed by the SEC.

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Sources of Finance

• Foreign Domestic markets: Another way to raise money internationally is to sell securities directly in the domestic capital markets of foreign countries.

• Example would be an Indian co. issuing securities in $s in the capital markets of USA.

• (Indian cos. have already tapped the US,UK, Japan and Switzerland markets.)

• The foreign issuer has to satisfy all regulations applicable to the domestic firms. There may be in fact additional obligations to be fulfilled by the foreign issuers.

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Sources of Finance

• The US Capital Market is the largest with a very active derivatives market also.

• Under Rule No. 144A under the Securities Act of 1933, Yankee bonds can be issued to QIBs without much restrictions which are applicable to the securities issued to the general public.

• (Yankee bonds are bonds issued in $s in USA by issuers of other countries.

• Similarly Bull Dogs, Samurais and Matilda or Kangaroos are bonds issued in Stg. Pds., Japanese Yen and Australian $s in the respective countries by issuers of other countries.)

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01/01/2010 618

Sources of Finance

• Export Credit Schemes: The Governments of a number of countries like US, Japan and India have created ‘EXIM’ banks for financing exports of capital goods and related technical services.

• Under the ‘Berne Union’ conventions, the EXIM banks’ interest rates applicable for export credits to Indian companies are regulated.

• Both Buyers’ credits as well as Suppliers’ credits are provided.

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Sources of Finance

• Buyers’ Credits: Under this Scheme, credit is provided directly to the Indian buyer of capital goods/technical services from the overseas exporter.

• The steps involved in this process are:• The overseas exporter and the Indian buyer

negotiate the contract;• Application for the Buyer’s credit is submitted to

the Export Credit Agency of the exporter’s country; processed by the agency and is approved;

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Sources of Finance

• The loan agreement containing the terms and conditions of the buyer’s credit is negotiated between the exporter’s bank and the Indian borrower (and the guarantor if any of the Indian borrower) and entered into.

• Suppliers’ Credit: This is a credit provided to the overseas exporters so that they can make available medium term finance to Indian importers.

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Sources of Finance

• The steps involved in the process are:• The overseas exporter notifies his bank and the

export credit agency of a potential export order from an Indian buyer, requiring medium term finance;

• The export credit agency communicates its willingness to provide the facility;

• The terms of the facility are incorporated in the contract between the overseas exporter and the Indian buyer.

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Sources of Finance

• The salient features of the finance provided by the export credit agencies are:

• The finance is tied to import of goods and services;

• Up to 85% of the value of imports is available as finance;

• Finance available for long tenors at reasonable cost;

• Finance is provided against the guarantees of the buyer’s bank (in the case of buyer’s credit) and the seller’s bank (in the case of seller’s credit).

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Sources of Finance

• Project financing structures: Full recourse structure and Limited recourse structure:

• Full recourse structure: The features are:• If the project is implemented by a new company,

the borrowings of the co. are backed by charge on all the existing and future assets of the co.

• If an existing co. borrows for a new project, then the new lender gets a ‘pari-passu’ charge over all the existing and future assets of the co. along with the other lenders.

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Sources of Finance

• The viability of the project would be assessed on a stand-alone basis but the stand alone cash flows as well as the total cash flows of the company are taken into account to judge whether the company would be in a position to service the existing as well as the proposed debts.

• In addition to the above charges, the lenders sometimes insist on the personal guarantee of the promoters also and a corporate guarantee of one of the group companies.

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Sources of Finance

• Limited recourse structure: Of late private participation in infrastructure projects is increasing. The salient features of the structure are:

• The project is set up as a separate company as an SPV;

• The pvt. sector promoter usually takes a major stake in the equity of the project and enjoys the over-all responsibility for running the project;

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Sources of Finance

• The pvt. sector promoter provides stand-by support for cost overruns if the quantum of such support is crystallised before the financial closure;

• The cash flow of the SPV is handled by a Trust or in an escrow account for appropriating the cash flows in the predetermined manner for various requirements of the project as well as debt servicing. After all the requirements are met, the residual cash flow is available to the project company.

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Sources of Finance

• In some cases, the government guarantee may be available;

• Lenders do not have recourse to the sponsors and their other assets.

• Financial closure: Financial closure means that all the sources of funds for the project have been tied up.

• Generally in the case of infrastructure projects, financial closure takes more time since the lenders have to satisfy themselves about all the issues concerned before committing their funds.

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Sources of Finance

• In general, financial closure can be achieved early if:

• Suitable credit enhancements (additional securities) are done to the satisfaction of the lenders;

• Underwriting arrangements are made for market related securities offerings;

• The credit worthiness and reputation of the sponsors is well established and

• The proposal is simultaneously processed by all the proposed lenders and coordinated among themselves.

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Cost of Capital

• The cost of capital assumes significance since:• The project has to earn an IRR which can

satisfactorily meet the cost of the funds obtained for financing the project.

• It is used as the discount rate to determine the NPV of the project or the cut-off or the hurdle rate with which to compare the IRR.

• Understanding of the cost of capital is essential to take the correct decision about the LT as well as ST borrowings, leasing etc.

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Cost of Capital

• Where different sources of funds are employed, the project financing mix has to be adjusted in such a manner as to result in as low a cost of capital as possible.

• Composite Cost of Capital: When the firm gets its LT funds from different sources, the weighted arithmetic average of the cost of the different sources constitutes the firm’s cost of capital.

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Cost of Capital

• Let us take a simple example: A firm has 30% equity with cost of equity at 20% and LT debt of 70% with cost of debt at 15%. Then the composite cost of capital would be: (0.3*0.2%) + (0.7 * 0.15%) = 16.5%.

• By extending the number sources of finance to n, the composite cost of capital = p1k1+p2k2+……+pnkn, where p1, p2…pn are the proportions of the first, second…nth source and k1, k2….kn are the costs of the first, second…nth sources of finance.

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Cost of Capital

• If a combination of equity, retained earnings, preference shares and debt is considered, the formula can be restated as follows:

• K0 = w1ke+w2kr+w3kp+w4kd, where K0,, ke, kr, kp and kd are the Composite

cost of capital, cost of equity, cost of retained earnings, cost of preference equity and cost of debt respectively and

w1, w2, w3, w4 are the respective weights representing the proportion of capital from the concerned source , to the total capital employed.

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Cost of Capital

• See some examples in the notes.• Since project financing concerns the present

and the future transactions of raising equity or contracting debts, we should consider the marginal cost of the specific sources of financing we are selecting and not the weighted average of the existing mix of finance.

• Cost of equity capital: It is the minimum rate of return that is expected on the equity financed portion of its investments in order to keep in tact the market price of the firm’s stock.

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Cost of Capital

• Some of the methods of computation of the cost of equity are : Historical rates of return; CAPM and Dividend growth model.

• In the Historical Rate of return approach, the past rate of earnings on equity is taken as the basis for determining the future cost of equity capital.

• The CAPM, as a framework for investment projects, implies that projects should be judged with reference to their systematic risk.

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Cost of Capital

• The appropriate discount rate for the project is given by the formula:

Ki = Rf + βi (km – Rf) :where Ki = rate of return required on equity, Rf = Risk free rate of return, βi = beta of security and km = rate of return on the market portfolio.

• Dividend Growth Model: In this model, the cost of equity will be the market rate of discount that equates the present value of all anticipated future dividends with the prevailing price of the stock.

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Cost of Capital

• If dividends are expected to grow at a constant rate g, and the cost of equity ke >g, the cost of equity is given by the equation:

Ke = (D1/P0) + g, where D1 = the dividend that is expected to be paid at the end of period 1 and P0 is the value of a share of stock at time 0.

• For example, if a company expects to pay a dividend of Rs. 15 per share at the end of period 1, and that the co’s earnings and dividend per share are expected to grow………

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Cost of Capital

• ……. at 3% in line with the growth in the economy and the current price of the share is Rs. 180, the cost of equity capital will be : ke = (15/180) + 0.03 = 11.33%

• (If constant growth rate in the dividend cannot be assumed , and a tapering off of the growth rate is anticipated, the equation can be modified to incorporate such deviations, if they are defined in terms of the time frame and quantum.) .

• Whatever be the model, the measure of cost of equity would only be an approximation and not precise.

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Cost of Capital

• Factors affecting the weighted average cost of capital: The WACC is affected by several factors, some of which are dependent on the investment and financing policies of the co. and some are beyond the control of the co.

• The factors which depend on the co.’s policies are :

• Investment policy (If the riskiness of the proposed investment is different from the riskiness of the existing investments, then the marginal cost of capital would reflect the riskiness of the proposed investments.)

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Cost of Capital

• Capital Structure Policy: Since the post tax cost of debt is cheaper than the cost of equity, the co. may adopt the appropriate level of financial leverage.

• Dividend Policy.• The level of interest rate : Depending on the prevailing

levels of interest, the cost of debt and preference capital may change. Even the cost of equity will depend on the levels of interest rate since it affects the risk free interest rate.

• Market risk premium : This is the perceived risk of equity stocks.

• Tax rates.

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Cost of Capital

• Cost of Debt : The after tax cost of debt is the discount rate which equates the net proceeds of the debt issue with the present values of the outflows in the form of interest and principal repayments, adjusted for the tax effect. The equation is :

ki = k(1-t), where ki = the net proceeds of the debt issue, k is the IRR or yield and t represents the tax rate.

• If interest is paid annually and redemption at maturity, the equation will become:……

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Cost of Capital

n• P = C (1-t) + F ,

t = 1 (1 + kd)1 (1 + kd)n

where P = net proceeds of the debt issue, C = Interest per annum, t = tax rate, F = redemption price, n = maturity period of debt.

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Cost of Capital

• Cost of preference capital: The case of redeemable pref. capital is similar to debt, the difference being pref. dividend is paid instead of interest, tax is not applicable and the discounting rate is kp the cost of pref. capital instead of kd the cost of debt.

• So the equation is: n P = D + F . , where.. i = 1 (1 + kp)i (1 + kp)n

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Cost of Capital

• P = net proceeds per pref. share, D= pref. dividend per share payable annually, F = redemption price, kp = post tax cost of debt and n = maturity period of pref. share.

• The approximate cost of preference capital is given by the equation:

kp = D + (F-P)/n (P + F )/2

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Cost of Capital

• For example, if a company issues pref. shares of face value Rs. 10 with a dividend of 10%, redeemable after 10 years, and the net amount realised per share is Rs.9.50, the cost of pref. share capital will be:

10 + (10-9.50)/10 = 10.05 = 10.31% (10 + 9.50)/2 9.75

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Cost of Capital

• Financing of project expansion: A new project may be implemented as a division of the parent co or it may be implemented through a separate company.

• If implemented as a division of the co., then the internal resources of generated by the co. can be partly used as it may not be sufficient.

• The other sources are unsecured deposits from the public, term loans, and issue of capital or debentures.

Page 646: Project Mgt

01/01/2010 646

Financial Institutions- IFCI

Financial institutions may be broadly categorised into two categories: All India financial Institutions and State Level FIs.

• The All India FIs are:●IFCI: IFCI offers the following wide range of products. • Short-term Loans (upto two years) for different short

term requirements including bridge loan, Corporate Loan etc

• Medium-term Loans (more than two years to eight years) for business expansion, technology up-gradation, R&D expenditure, implementing early retirement scheme, Corporate Loan, supplementing working capital and repaying high cost debt .

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01/01/2010 647

IFCI

• Long-term Loans (more than eight years to upto 15 years) - Project Finance for new industrial/ infrastructure projects, ‘Takeout Finance’, acquisition financing (as per extant RBI guidelines / Board approved policy), Corporate Loan, Securitisation of debt

• Structured Products: acquisition finance, pre-IPO investment, IPO finance, promoter funding, etc.

• Lease Financing • Takeover of accounts from Banks / Financial

Institutions / NBFCs.

Page 648: Project Mgt

01/01/2010 648

IFCI

• Financing promoters’ contribution (private equity participation)/subscription to convertible warrants

• Purchase of Standard Assets and NPAs • IFCI customizes the product-mix to suit the

business/industry.• Targeted Business Segments:

IFCI has been meeting the changing requirements of the clients through financial products for multiple industry sectors.

• Major Financing Schemes of IFCI includes Project Financing and Financial Services mainly to the manufacturing industry along with a diversified industrial portfolio.

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IFCI

• Public Sector Undertakings • Manufacturing industry • Infrastructure projects

– Power – Airports (brown field) – Ports– Hotels – Urban infrastructure projects

• NBFCs • Participation in Private Equity

– Promoter funding

Page 650: Project Mgt

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IFCI

• Corporate Advisory Services• Corporate advisory & infrastructure services• Infrastructure advisory• Monitoring agency for public issues• Restructuring advisory services• Bid process management• Corporate advisory & infrastructure services:

India is throwing up investment avenues in newer sectors and projects, and IFCI fills up the critical need to provide specialised advisory services to the Indian Corporate Sector in their efforts towards Industrial Advancement.

Page 651: Project Mgt

01/01/2010 651

IFCI

• As a catalyst of Industrial growth, IFCI provides the following Advisory Services:

• Investment appraisal of Navratna (most valued public sector companies) Companies.

• Project Conceptualization and related services, including Guidance in relation to Selection of Projects, Preparation of feasibility studies, DPR, Capital Structuring, Techno-economic Feasibility, Financial Engineering, Project Management Design etc.

• Credit Syndication including preparation of Information Memorandum, Syndication of domestic/foreign loans, Post Sanction follow-up, Assistance in legal documentation etc.

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01/01/2010 652

IFCI

• Documentation of various project documents.• Infrastructure advisory:• IFCI offers a range of services to the

Infrastructure Sector, with specific emphasis on roads, ports, power and urban infrastructure - total solutions starting from the stage of investment identification to financial closure are provided.

• The services provided in the Infrastructure Sector include:

• Facilitation of Credit Documentation. • Due Diligence.

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01/01/2010 653

IFCI

• Agreements & Document Review/Advice. • Pre-Investment Review. • Project Conceptualization and Feasibility

Studies. • Risk Allocation, Assessment & Reasonableness

of Cost. • Advise on Financing Options – Sources, Cost &

Risk. • Financial Analysis & Modeling – Scenario

Analysis. • Potential JV/Partner Profiling.

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01/01/2010 654

IFCI

• Negotiating Support for Equity Buy In. • Project Evaluation. • Credit Syndication – Domestic & Overseas. • Arranging Deferred Payment Guarantee, ECB. • Placement of debt & equity. • Capital Market Advisory Services.• As per the SEBI (Disclosure & Investor

Protection) Guidelines, 2000, in case of issues exceeding Rs.500 crore, the issuer shall make arrangements for the use of proceeds of the issue to be monitored by one of the financial institutions.

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IFCI

• IFCI offers its services as Monitoring Agency for the same:

• Carrying out of Post-Issue due diligence; • Ascertaining whether the utilization of issue

funds has been made for the purposes and in a manner as envisaged by the Offer Document;

• Preparation of Monitoring Report as per the format specified at Schedule-XIX of the above guidelines;

• Submission of the report to the SEBI on a half-yearly basis, till the completion of project, for the purposes of record.

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IFCI

• Restructuring advisory services:• Advisory Services to corporate and government

clients comprising financial restructuring, operational restructuring, cost-structure studies and process analysis & improvement:

• Organizational Structural Changes • Analysis of the Operational Performance. • Study of the Existing Organizational Structure. • Study of the Existing Statutes & Rules and

Regulations. • Market Analysis with respect to products.

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IFCI

• Review of the Domestic & International Scenario. • Valuation of Fixed Assets and Inventory. • Advising on Formation of New Entity. • Preparation of relevant Agreements/ Legal

Documents. • Buy/Sell Advisory • Purchase, sale, transfer of assets, operating and

technology rights, brands, business operations, divisions and corporate entities.

• Separation, liquidation, disposal of non-strategic ventures, assets or liabilities.

Page 658: Project Mgt

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IFCI

• Mergers, Joint Ventures and Alliances • Drafting information memoranda for potential

buyers/ sellers. • Locating suitable counter-parties. • Assessing and advising on augmenting the

viability. • Determining of share exchange ratio. • Structuring and negotiating of terms and

conditions for the new entity. • Managing and monitoring of the documentation,

transaction and transition process.

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IFCI

• Privatisation • Conducting the SWOT Analysis and based on

the same, to prepare an appropriate package. • Assessment & Valuation of assets. • Valuation of company as a going concern. • Suggesting measures to enhance sale value. • Financial restructuring, if any. • Preparation of Information Memorandum.• Bid process management:• IFCI has successfully handled several Bid

Process Management Assignments.

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IFCI

• IFCI offers a range of services under the Bid Process Management: -

• Preparation of Bid Documents (for various modes of Bid process) and Advertisement inviting Expression of Interest (EOI);

• Evaluation of Bids and Assisting till the final award of Contract.

• It provides long term finance to the industries and issues guarantees on their behalf. It also has soft loan schemes and provides Risk Capital Assistance sponsored by the Risk Capital and Technology Finance Corporation Ltd.

Page 661: Project Mgt

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ICICI, IDBI

● ICICI: It has been specialising in providing term loans in foreign currencies, extending underwriting assistance and issuing guarantees.

● It also grants rupee loans and has a Merchant Banking Cell to give specialised services in project planning and formulation.

●IDBI: Under the Project Finance scheme IDBI Bank provides finance to the corporates for projects in both rupee and foreign currencies for Greenfield projects as also for expansion, diversification and modernization.

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IDBI

● IDBI Bank follows the Global Best Practices in project appraisal and monitoring and has a well-diversified industry portfolio.

●IDBI Bank has signed a Memorandum of Understanding (MoU) with LIC in December 2006 for undertaking joint and ‘take-out’ financing of long-gestation projects, including infrastructure projects.

● IDBI Bank has been actively participating in structuring and financing of infrastructure projects in the areas of power, telecom, roads, seaports, railways and logistics as well as Special Economic Zones.

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IDBI

●The Bank has also taken initiatives in funding modernization of airports, besides part-financing development of international airports and seaports under the Public-Private Partnership route.

●The Bank is also a member of the Core Committee of the Government set up for finalisation of the Ultra Mega Power Projects (UMPPs).

● IDBI Bank interacts with Government and other stakeholders and market participants, on policy and operational issues, facilitating smooth flow of funds to infrastructure sector.

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IDBI

●It operates Bill discounting and technical development fund schemes.

● It also augments the funds of the State level financing institutions by subscribing to their bonds.

● IDBI has a Bill discounting scheme through which it provides refinance assistance to SSFCs, SIDCs and commercial banks.

• UTI, GIC, LIC: They assist industrial projects by mainly participating in consortium arrangements for providing equity support and underwriting assistance and granting term loans.

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IIBI, SIDBI

• Industrial Investment Bank of India (IIBI) (Formerly Industrial Reconstruction Bank of India –IRBI): It specialises in providing rehabilitation assistance to sick units.

• National small Industries Corporation (NSIC), • SIDBI: It takes care of the needs of the Small

Scale and SME sector industries. • The State Level FIs are: SFCs and SIDCs.

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IDFC

• Infrastructure Development Finance Co. Ltd. (IDFC):

• (For more details pl. see http://www.idfcpe.com/pages/main1.html and http://www.idfc.com )

• IDFC’s mission is to be the financier of and advisor of choice for infrastructure in India.

• It is focussed on growing its balance sheet through project finance, and building up innovative fee based business from asset management, project development and advisory services.

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IDFC

• IDFC finances projects for electricity generation, transmission and distribution, as well as projects in the oil and gas industry.

• The other sectors financed by IDFC are in the urban infrastructure development - urban transportation(-roads, ports, airports, railways and pipelines),

• solid waste management, • industrial water supply,

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IDFC

• telecommunications (cellular, basic, long distance and international and cable -- new projects and acquisition finance for consolidation),

• tourism, SEZs, townships, IT parks, and • commercial and retail real estates • Under the ‘viability gap funding’ mechanism

announced by the GOI, whereby the GOI funds upto 20% of the project cost under the Public Private Partnership model, the IDFC funds the private sector entrepreneurs for projects in the above mentioned areas.

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IDFC, IIFCL

• IDFCPE ( a 100% subsidiary of IDFC) was established in 2002, is India’s largest and most actives Private Equity focussed on infrastructure and is managing a corpus of Rs. 57.2 billion.

• India Infrastructure Finance Company Ltd (IIFCL) :

• Although there has been progress in attracting private investments into infrastructure, Gross Capital Formation (GCF) in infrastructure has hovered around 5 percent  of Gross Domestic Product (GDP)

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IIFCL

• The 11th Five Year Plan (2007-2012)  has envisaged raising the level of GCF in infrastructure to 9 percent of GDP by 2012 , thereby matching the levels obtaining in some of the Asian economies.

• Government of India, accordingly approved a Scheme for Financing Viable  Infrastructure Projects through a Special Purpose Vehicle called the  India Infrastructure Finance Company Ltd, broadly referred to as SIFTI.

• Accordingly, India Infrastructure Finance Company Ltd (IIFCL) was established in January 2006 as a wholly owned Government of India company and commenced its operations from April 2006.

Page 671: Project Mgt

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IIFCL

• IIFCL  shall finance only commercially viable infrastructure projects. In order to be eligible for funding by IIFCL, the following will be the eligibility criteria:

• Eligibility • The project shall be implemented by : A Public

Sector Company ; A Private Sector Company selected under a Public-Private Partnership (PPP) initiative a private sector company provided it has undertaken a project where the service to be provided is regulated or the project is being set up under an MoU arrangement with the Central, any State government or a Public Sector Undertaking.

Page 672: Project Mgt

01/01/2010 672

IIFCL

Total lending for such private projects shall not exceed 20% of the lending programme of the company in any accounting year The tenor of IIFCL lending should be larger than that of the longest tenor commercial debt by at least two years. The project should be from one of the following sectors : Roads and bridges, railways, seaports, airports, inland waterways, other transportation projects; Power; Urban transport, water supply, sewage, solid waste management and other physical infrastructure in urban areas; Gas pipelines Infrastructure projects in Special Economic Zones (SEZs) and International Convention Centres and other tourism infrastructure projects.

Page 673: Project Mgt

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IIFCL

• Projects which are set up on “non-recourse” basis would only be eligible for financing by IIFCL.

• Disbursement of loans by IIFCL is subject to the appraisal being done by reputed appraising institutions and the lead bank accepting and adopting the same.

• IIFCL shall disburse the loan only after getting the sanction from the Lead Bank.

• IIFCL would not normally carry out any independent appraisal of the project.

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IIFCL

• Lead Bank shall be responsible for regular monitoring and periodic evaluation of compliance of the project with the agreed milestones. 

• Lending Terms:• IIFCL may fund viable infrastructure projects

through the following modes:• Long term debt; Refinance to banks and

financial institutions for loans with tenor of more than 10 years granted by them; Any other mode approved by Government of India. 

Page 675: Project Mgt

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IIFCL

• Total lending to any project by IIFCL  shall not exceed 20% of the total project cost subject to exposure of IIFCL being less than that of the lead bank.  

• Lending to PPP projects • A project awarded to private sector company through

PPP shall be accorded priority for lending by IIFCL. • A PPP project has been defined under the Scheme

as a project based on a contract or concession agreement between a government or a statutory entity on the one side and a private sector company on the other side, delivering an infrastructure service on payment of user charges.

Page 676: Project Mgt

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IIFCL

• In case of PPP projects, the private sector company shall be selected through a transparent and open competitive bidding process. 

• PPP projects based on standardized/model documents duly approved by the respective government would be preferred.

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General: All India Financial Institutions

• In general, the wide range of categories of financial Assistance given by the all India FIs are:

Rupee Term Loans; Foreign Currency Term Loans; Underwriting of equity capital, Preference Capital, Debentures and bonds; Direct subscription to Capital; Guaranteeing loans raised by industrial concerns from different sources including commercial banks and extending guarantees in respect of deferred payments by importers; Bill rediscounting; Operation of Technical Development Fund; Soft Loan Schemes; Equipment Financing; Lease Financing; Seed Capital Assistance; and Risk Capital Assistance.

Page 678: Project Mgt

01/01/2010 678

SFCs, EXIM Bank

• The financial assistance provided by the State Level Corporations are:

Term Loans; Underwriting of shares and Direct subscription to capital.

• Exim Bank : Backs up the exporter of Project exports, every step.

● From identifying global opportunities, preparing competitive bids, to guarantees and financial support, till the projects are successfully completed.

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EXIM Bank

●From power generation, transmission & distribution, dams, tunnels, oil exploration, to supply of capital goods and consultancy services, the range is wide. (More details are available in Exim Bank’s website under Lines of Credit.)

● The programmes of lending are under the Suppliers’ Credit to the Indian Exporter, under the Buyers’ Credit to the buyer of Indian goods/projects, and under the Lines of Credit to the foreign governments, FIs and banks.

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NABARD

• NABARD extends credit to agriculture, allied small-scale industries, cottage and village industries, and handicraft and allied activities.

● It also refinances the commercial banks against their lending to these sectors.

● It gives expert advice on projects formulation, implementation etc. to the sponsors of projects in the above areas and also refinances banks which gives such project loans.

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International Financial Institutions- IFC

• International Finance Corporation (IFC), a member of the World Bank group:

• Products & Services:• IFC is a dynamic organization, constantly

adjusting to the evolving needs of its clients in emerging markets. Apart from Project Finance to companies in developing countries, it also has:

• Developed innovative financial products • Broadened its capacity to provide advisory

services.

Page 682: Project Mgt

01/01/2010 682

IFC

• Financial Products:IFC continues to develop new financial tools that enable companies to manage risk and broaden their access to foreign and domestic capital markets. Its financial products include:

• Loans for IFC's Account • (IFC offers fixed and variable rate loans for its

own account to private sector projects in developing countries. These loans for IFC's own account are called A-loans.)

• Most A-loans are issued in leading currencies, but local currency loans can also be provided.

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01/01/2010 683

IFC

• The loans typically have maturities of 7 to 12 years at origination.

• Grace periods and repayment schedules are determined on a case-by-case basis in accordance with the borrower's cash flow needs.

• If warranted by the project, IFC provides longer-term loans and longer grace periods.

• Some loans have been extended to as long as 20 years.

• IFC operates on a commercial basis. It invests exclusively in for-profit projects and charges market rates for its products and services.

Page 684: Project Mgt

01/01/2010 684

IFC

• Loans from IFC finance both greenfield companies and expansion projects in developing countries.

• The Corporation also makes loans to intermediary banks, leasing companies, and other financial institutions through credit-lines for further on-lending.

• The credit lines are often targeted at small and medium enterprises or at specific sectors.

• To ensure the participation of other private investors, A-loans are usually limited to 25% of the total estimated project costs for greenfield projects, or, on an exceptional basis, 35% in small projects.

Page 685: Project Mgt

01/01/2010 685

IFC

• For expansion projects IFC may provide up to 50% of the project cost, provided its investments do not exceed 25% of the total capitalization of the project company.

• Generally, A-loans range from $1 million to $100 million.

• The Corporation is willing to extend loans that are repaid only from the cash flow of the project, without recourse or with only limited recourse to the sponsors.)

• Syndicated Loans • Equity Finance

Page 686: Project Mgt

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IFC

• Quasi-Equity Finance • Equity & Debt Funds • Structured Finance • Risk Management Products • Local Currency Financing • Subnational Finance (Joint IFC-World Bank Subnational Finance

Department : The Subnational Finance Department is a combined initiative of the World Bank and the International Finance Corporation.

Page 687: Project Mgt

01/01/2010 687

IFC

IFC provides states, provinces, municipalities, and their enterprises with financing and access to capital markets, without sovereign guarantees.

On a selective basis it also provides financial support to nationally owned enterprises operating in natural monopoly infrastructure sectors.

In all of its financings its primary objective is to strengthen the borrowers ability to deliver key infrastructure services such as water, wastewater management, transportation, gas and electricity, and to improve their efficiency and accountability as service providers.)

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IFC

• Trade Finance• Advisory Services:• IFC offers a range of advisory services in

support of private sector development in developing countries.

• IFC Project Cycle:IFC offers a wide variety of financial products to private sector projects in developing countries.

• The project cycle illustrates the stages a business idea goes through as it becomes an IFC-financed project.

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IFC

• Stages of the Project Cycle• Application for IFC Financing • A company or entrepreneur, foreign or domestic,

seeking to establish a new venture or expand an existing enterprise can approach IFC directly.

• After the initial contacts and a preliminary review, IFC may request for a detailed feasibility study or business plan to determine whether or not to appraise the project.

• Project Appraisal • Typically, an appraisal team consists of an investment

officer with financial expertise and knowledge of the country in which the project is located, an engineer with the relevant technical expertise, and an environmental specialist.

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IFC

• The team visits the site of the proposed project, holds extensive discussions with the project sponsors and evaluates the technical, financial, economic and environmental aspects of the project.

• After returning to headquarters, the team submits its recommendations to senior management of the relevant IFC department.

• If financing of the project is approved at the department level, IFC's legal department, with assistance from outside counsel as appropriate, drafts appropriate documents.

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IFC

• Outstanding issues are negotiated with the company and other involved parties such as governments or financial institutions.

• Public Notification • Before the proposed investment is submitted to

the IFC Board for review, the public is notified of the main elements of the project.

• Environmental review documents are also made available to the public.

• Board Review and Approval • The project is submitted to IFC's Board of

Directors, which reviews the proposed investment.

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IFC

• Resource Mobilization • IFC seeks to mobilize additional finance by

encouraging other institutions to make investments in the project.

• Legal Commitment • If the investment is approved by the Board, and

if stipulations from earlier negotiations are fulfilled, IFC and the company will sign the deal, making a legal commitment.

• Disbursement of Funds • Funds are disbursed under the terms of the legal

commitment signed by all parties.

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IFC

• Project Supervision • Once funds have been disbursed, IFC monitors

its investments closely. • It consults periodically with management, and it

sends field missions to visit the enterprise. • It also requires quarterly progress reports

together with information on factors that might materially affect the enterprise in which it has invested, including annual financial statements audited by independent public accountants.

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IFC, ADB

• Closing • When an investment is repaid in full, or when

IFC exits an investment by selling its equity stake, IFC closes its books on the project.

• Asian Development Bank (ADB):• ADB extends loans and provides technical

assistance to its developing member countries for a broad range of development projects and programs.

• It also promotes and facilitates investment of public and private capital for economic and social development.

Page 695: Project Mgt

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ADB, OECF

• A project information document (PID) is summary information on an ADB-assisted project.

• Japanese Overseas Economic Cooperation Fund (OECF) :

• Assistance Scheme/Program: The OECF provides long-term, low interest loans and/or takes equity in significant private sector projects which are linked to the fulfillment of its objectives.

• Loans to and investments in Japanese corporations engaged in development projects in developing countries can also be made.

Page 696: Project Mgt

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OECF

• Criteria : Any developing country can apply for assistance under OECF’s many programs. While a Japanese partner is not mandatory, the process takes place in Japan and support from a Japanese partner is usually imperative.

• Priority will be given to the sectors of energy, transportation, agriculture and education.

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FIs’ guidelines for funding projects:

• The FIs’ general approach to project financing: The FI/Bank receiving an application from the project sponsor scrutinises the proposal from various angles as follows - to decide whether to commit funds to the project or not, if yes, in what form, up to what extent, timing of releasing the funds, periodicity of recovery of interest and principal etc.

• Whether the project is acceptable - by examining the salient features such as the background and experience of the applicant, particularly in the line of activity;

Page 698: Project Mgt

01/01/2010 698

FIs’ guidelines for funding projects:

• The potential demand for the project;• The availability of the required inputs and utilities

and other infrastructural facilities;• Whether the project is in keeping with the

priorities if any laid down by the Government;• The Co’s Memorandum and Articles of

Association to ensure that : there are no clauses prejudicial to the lender’s interest and no limitations have been placed on the Co’s borrowing powers and operations.

• A credit report from the co’s existing bankers to ensure the creditworthiness of the borrower;

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FIs’ guidelines for funding projects:

• The line of activities and financial position of the associate/subsidiary concerns if any, and the cos’ financial involvement in them and the overall structure of the inter-corporate investments (the purpose of this is to study the effect of diversion of resources of the co. to its associates/subsidiaries);

• If any redeemable pref. shares or debentures are issued, whether the redemption reserves have been adequately built up;

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FIs’ guidelines for funding projects:

• Particulars of the project along with the copy of the project report furnishing the details of the technology, manufacturing process, availability of construction /production facilities; (Comments about the technical/financial collaborators, technical feasibility, cost of the project, suppliers of the plant and machinery, etc.)

• Estimates of the cost of the project, detailing the itemised assets acquired/to be acquired, including the preliminary/preoperative expenses and working capital margin requirements;

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FIs’ guidelines for funding projects:

• Details of the proposed means of financing, indicating the extent of promoters’ contribution, quantum of share capital to be raised through public issue, the composition of debt – term loans, deferred payment guarantees, foreign currency loans if any, etc.;

• Working capital requirements at the peak level during the first year of operations after commencement of commercial production and the banking arrangements to be made for financing the WC requirements;

• Project implementation schedule together with Bar Chart, PERT/CPM Chart;

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FIs’ guidelines for funding projects:

• Organisational set up with the list of Board of Directors, the qualifications, experience and competence of the key personnel to be in charge of the implementation of the project during the construction period and the executives to be in charge of the functional areas of purchase, production, marketing and finance after commencement of commercial production;

• Demand projection based on the overall market prospects together with a copy of the market survey report;

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FIs’ guidelines for funding projects:

• Estimates of sales, cost of production and profitability;

• Projected Profit and Loss account and balance sheet for the operating years during the currency of the bank’s term assistance;

• (Financial analysis : For an existing company, comments about D/E ratio and the Current Ratio – whether they are in acceptable range? ----D/E ratio < 2 and CR >1.33

• Method of depreciation followed, changes made and their implications on profit;

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FIs’ guidelines for funding projects:

• Revaluations of fixed assets made in the past and the quantum of revaluation reserves;

• Status of Co.s’ Income tax and sales tax assessments and provisions made for the current year;

• History of past sickness or any defaults made in the past;

• Nature and purpose and quantum of contingent liabilities;

• Pending law suits by and against the co. and their financial implications;

Page 705: Project Mgt

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FIs’ guidelines for funding projects:

• Qualified remarks by the statutory auditors)• Proposed repayment programme;• Projected funds flow statement covering both the

construction period and the subsequent operating years during the currency of the term loan;

• Details of the nature and value of securities offered; (Comments on the type of charges to be created, in the case of sureties be they the co’s directors or third parties, their networth etc.)

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FIs’ guidelines for funding projects:

• Consents from the Government and other authorities and any other relevant information. (Comments on the Industrial licence if any obtained by the co., approval of collaboration/technical know-how agreement, clearance for import of plant and machinery, no objections from the local authorities, clearance from environmental pollution angle, etc.)

• (In the case of the existing concerns) particulars regarding the history of the concern, its past performance, present financial position etc. duly supported by the statements such as P & L account and B/S for the past years.

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FIs’ guidelines for funding projects:

• The Application in the standard format of the lending institution duly completed in all respects, signed by the authorised signatories and submitted will form the basis for the detailed appraisal of the project by the lending institution.

• After a thorough examination of the various aspects detailed above, the institution visits the project site or the factory site (In the case of the existing units).

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FIs’ guidelines for funding projects:

• Each project is examined in proper perspective having regard to its natures, size and scope. For example, the approach for appraising the proposal of an existing concern going in for expansion or modernisation , an existing concern setting up a new project, and new concern venturing to set up a new project will all be different.

• The ultimate objective of the lender’s appraisal exercise is to ascertain the viability of a project with a view to ensuring the repayment of the loan with interest.

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FIs’ guidelines for funding projects:

• In the appraisal exercise, all the data/information should be checked and wherever possible, counterchecked through inter-firm inter-industry comparisons.

• When the lender is confident of the success of the project after a thorough appraisal, it issues a ‘Sanction Letter’ to the co. along with the detailed list of terms and conditions/covenants;

• creation of charges in favour of the lenders;• disbursement of the loans in stages as agreed

between the lenders and the co. depending upon the projected cash flows;

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FIs’ guidelines for funding projects:

• and monitoring of the progress of the project and recovery of the interest and principal.

• Depending on the size of the loan, more than one bank/institution may participate in the lending with a view to share the risk.

• In such a case, the co. appoints one bank as the ‘lead bank’ , and prepares an ‘Information Memorandum’.

• The lead bank enlists the services of some other banks in sharing the lending based on the Information Memorandum.

• This process is known as ‘Syndication’.

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FIs’ guidelines for funding projects:• For term loans, the lenders also charge a

“processing fee’ of about 1% of the loan amount. There may be an initial repayment holiday, till the project starts commercial production and then the repayments of the principal and interest due would begin at monthly, quarterly or half yearly intervals depending on the cash flows projected.

• Since the lending institutions will charge penal interest on the ‘overdue’ amounts (i.e. the amounts of principal and or interest not paid on due dates), the project manager has to correctly calculate the cash outflows on account of these dues.

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FIs’ guidelines for funding projects:

• Usually the loan documents stipulate certain covenants such as: the board should have a nominee from the lenders, additional funds should be brought in by the promoters in case of overrun; bar to undertake any new project until the dues are paid in full; restrictions on transfer of shares of promoters to others, payment of dividends with the permission of lenders etc.

• Working Capital Advances: Used for financing the current assets.

• In the pre-production stage, finance is given in the form of Cash Credit/Overdraft/Letter of Credit.

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FIs’ guidelines for funding projects:

• Under the Cash Credit/Overdraft system, the bank fixes the maximum amount that the co. can draw for its operations, called the ‘limit’.

• Interest is charged periodically on the actual amount utilised by the co.

• The operations are reviewed at the end of every year and then renewed for another year.

• In the case of loans, the limit amount assessed for working capital needs of the co. is given in the form of a loan and interest is charged on the entire loan amount till it is repaid.

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FIs’ guidelines for funding projects:

• In some cases, the supplier of RM may demand an LC in which case the bank gives the LC facility also to the co. as part of the WC limits.

• LC is opened in favour of the supplier of the RM, and on receipt of the stipulated documents form the supplier, the bank pays the supplier. The amount is then recovered by the bank from the co.

• In the post production stage, the co. sells its products, raises bills on its customers, some of whom avail some credit periods for repayment.

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FIs’ guidelines for funding projects:

• The bank discounts such bills on the co.’s debtors and credits the amount to the Cash Credit/Overdraft account. Thus the cycle goes on.

• Some of the typical covenants the FIS/banks impose in their Sanction Letters:

• The bank/FI has the right to examine the books of accounts and inspect the co’s factories at the co’s cost.

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FIs’ guidelines for funding projects:

• During the currency of the loan: the co. should not alter the capital structure, should not formulate any scheme of

amalgamation/merger, should not undertake any new project, or

expansion scheme, should not invest or lend to others other than

normal trade credits, should not enter into any borrowing

arrangements with any other lender,

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FIs’ guidelines for funding projects: should not declare dividends except out of profits, should not create any charge on the assets of the

co. in favour of any other FI/bank or persons, should not undertake any trading activity other

than the sale of its products, should not permit any transfer of the controlling

interest or make any drastic change in the management set-up.

should not repay the loans to its promoters/ directors/ friends /relatives without the written permission of the bank,

the bank will have the option of nominating a director on the board of the co. etc.

Page 718: Project Mgt

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Risk Analysis

• Risk is inherent in capital budgeting decisions, as the benefits and costs will extend over a long period.

• For simplicity, so far it has been assumed that the firm would face the same risk in the new projects, as it has been facing earlier in its existing business.

• Hence the average cost of capital was used for evaluating the new projects.

• But in reality the risk in every project may be different – for example, the risk in a research project may be much more (due to uncertainty of the outcome) than an expansion project.

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Risk Analysis• Therefore the risk in each project has to be

identified and measured separately so as to arrive at the correct conclusions.

• If in a given situation, all the future events are known beforehand, it is described as certainty.

• Uncertainty the opposite condition is the situation in which the future events are not known.

• Risk is a situation, where the possible events are known, but which of those will actually happen is not known.

• However, the probability of their occurrence can be determined.

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Risk Analysis

• Risk analysis is a complex area in Project. • There are different techniques that are applicable

for the ‘stand-alone’ risk of a project and the risk that the project in the context of the firm.

• Sources, measures and perspectives on risk:• Risks can be broadly classified into two categories

: Business risk and financial risk. All kinds of risk can be included in one of the these two risks.

• Risks may be project-specific, competitive risk, industry-specific risk, market risk and international risk.

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Risk Analysis

• Project specific risk: the earnings and cash flows of the project may be lower than expected because of estimation errors or due to some other factors.

• Competitive risk: Risk arises due to the unanticipated actions of the competitors.

• Industry –specific risk: arises due to changes in technology, regulations that are specific to the industry to which the project belongs. These risks will affect the cash flow and hence the earnings of the project.

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01/01/2010 722

Risk Analysis

• Market risk: arises due to changes in macroeconomic factors like fall in the GDP growth rate, interest rate, inflation rate, affecting the cash flows and earnings of the project.

• International risk: arises in the case of a foreign project due to changes in exchange rates or political conditions/decisions in the foreign country.

• The more important measures of risk are range, standard deviation, coefficient of variation and semi-variance.

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Risk Analysis

• The weighted NPV works out to 540.• The Range is 700 • Standard Deviation = { pi (xi – xa)2}½ where = Standard Deviation, pi = probability of the ith value, xi = ith

value , xa= expected value. • The of the NPV distribution = 249.8;• Variance = 2 = 62,400.

NPV Probability 200 0.3 600 0.5 900 0.2

•Let us take an example to explain the measures.

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Risk Analysis

• Coefficient of variation (CV): Standard Deviation (SD) is expressed in absolute values and so by comparing the SDs you cannot conclude which of them is better.

• For example, if you compare two projects with expected NPVs Rs. 10 million and Rs. 1 million with SDs of Rs. 1 lakh and Rs. 90000/- , comparison of SDs, will give a decision that the second project should be selected.

• The CV adjusts the SD for scale and is defined as: CV = SD/Expected value.

• So CV in the example = 249.8/540 = 0.46.

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Risk Analysis

• Semi Variance (SV) : SD considers all variances – both positive and negative. Since investors are concerned only about negative deviations, SV seems to be a more suitable measure of risk.

• SV = pidi’2, where di’ = di when di < 0 .• So in our illustrative example, SV = 34680.• By extension, the Semi SD = the square root of

the SV = 186.2 in the example.

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Risk Analysis

• SD and Variance are the most commonly used to measure risk, since:

• (a) SD has the same units as the original variable, and can be interpreted easily.

• (b) SD is the measure of dispersion which characterises the normal distribution. If a variable is normally distributed, its mean and SD contain all the information about its probability distribution,

• (c) it is easily tractable.

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Risk Analysis

• Use of subjective probabilities: Probability distribution is required to measure the expected value and dispersion.

• It may be possible to define the probability distribution with a high degree of objectivity, on the basis of past evidence.

• These are called ‘objective’ probability distribution.

• But in real life, such objective evidence may not be available for defining probability distributions.

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01/01/2010 728

Risk Analysis

• In such cases, the experience and judgment of some knowledgeable persons is pooled to define the Prob. Distribution.

• These are ‘subjective’ probability distributions.• Perspectives on risk: Irrespective of the

measure of risk used, there can be at least three perspectives and they are:

• Stand-alone risk: Represent the risk of a project, when it is viewed in isolation;

• Firm risk: (Also known as Corporate Risk’). This reflects the contribution of the project to the risk of a firm.

Page 729: Project Mgt

01/01/2010 729

Risk Analysis

• Systematic risk: (also called the market risk), this represents the risk of a project from the point of view of a diversified investor.

• Methods of Risk Adjusted Investment appraisal: Let us see how to incorporate the risk factor into the investment appraisal.

• Certainty Equivalent method: This method is based on the utility of the decision maker.

• For example consider the scenarios of cash flows in a project and their probabilities in the second year : Rs. 20000 – 75% and Rs. 30000 – 25% .

• So the expected inflow in the second year is Rs. 22500.

Page 730: Project Mgt

01/01/2010 730

Risk Analysis• The Project Manager would rather prefer a certain

outcome of Rs. 10000 rather than Rs. 22500 which is subject to some probabilities.

• Here the Certainty Equivalent Co-efficient of the cash flows is worked out as: 10000/22500 = 0.44.

• This method is useful when the risk-return perceptions of the project manager differ from year to year.

• First the certainty equivalents are calculated and then the certainty equivalents of cash flows are calculated.

• The cash flows are then discounted with the risk free rate of discount, as the risk adjustment has already been made.

Page 731: Project Mgt

01/01/2010 731

Risk Analysis

• 0 ≤ CEC ≤ 1. The higher the CEC, higher is the confidence of the management on the forecasted cash flows. As a general rule, the CEC reduces for the later years as risk increases.

• We can see an example to see how the CEC is applied.

• A co. has cost of capital 10%, and the risk free rate of discount is 8%, the project cash outlay is Rs. 10 lakhs, and inflows in the first and second years would be Rs. 20 lakhs and Rs. 25 lakhs. The project would have a life of two years and salvage would be negligible………..

Page 732: Project Mgt

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Risk Analysis

………The promoters’ estimates of the CEC for the two years would be 0.85 and 0.75. Find the risk adjusted NPV of the project.

• NPV = Rs. (20000 *0.85)/1.08 + (25000 * 0.75)/1.082 - 10 = Rs.31.79 lakhs.

• Risk adjusted Discount Rate Method: Since different projects have different risk levels, the discount rates also have to be different to reflect the risks.

• In the simple NPV method, it was assumed that the risk characteristics of the new projects are the same as the investments already made by the firm.

Page 733: Project Mgt

01/01/2010 733

Risk Analysis

• But in this approach, the new projects are discounted at the rate which incorporates the risk element of the new project.

• So the Risk Adjusted Discount (RAD) rate i’ consists of three components :

the risk free rate of discount r, the premium for the normal risk of the firm u and the premium for the extra or below normal risk of the new project, a. i.e i’ = r + u + a.

Page 734: Project Mgt

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Consider the following example for understanding how the RAD is applied.

Cash flow in years 1 to 5 Cash flows in years 6 to 10 Initial Outflow Probability Amount Probability Amount

0.20 2.0 0.20 2.60 0.40 2.40 0.60 3.20 0.30 2.80 0.10 3.40

14

0.10 3.40 0.10 3.60

Page 735: Project Mgt

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Risk Analysis• The co’s cost of capital is 13% and the extra

premium required for the new project is 2%.• Ans: Expected cash flows in each of the first

five years = Rs. 2.54; Expected cash flows in the years 6 to 10 (each) =

Rs. 3.14 ;• NPV = - 14 + 2.54 x PVIFA (15,5) + 3.14 x

PVIFA (15,5) x PVIF (15,5) = 0.255• In this example, the discount rate of 15% has

been used for al the 10 years. However, keeping in view the change in the risk factors, different discount rates may be used for different years.

Page 736: Project Mgt

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Risk Analysis• Calculation of Standard Deviation of NPV-: • Perfectly correlated cash flows are obtained when

there are no factors that cause uncertainty such as competition, non-availability of raw materials, fluctuation in demand etc.

• The behaviour of the cash flows in all periods is the same and they are linearly related to each other.

• In such cases,

n the expected NPV = {At/(1+i)t} – I ,

i =1

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Risk Analysis

n

and SD of the NPV = t/(1+i)t i =1

i= 1

• where At = expected cash flows, i = the risk free discount rate, t = life of the project and t = SD of the cash flows.

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Risk Analysis

• (See an example in ICFAI’s Finance Series Vol II –chapter 4: Pages 117 – 118: Data is given about the mean cash flows for the number of years, the respective SDs, and the risk free interest rate is given. And so the working is quite simple.)

• Uncorrelated cash flows: When the firm operates in conditions of uncertainty, the cash flows cannot be correlated, i.e. In conditions of severe competition, heavy ad. expenditure etc. which make the cash flows of each year independent of the others.

Page 739: Project Mgt

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•Here the formula for the NPV is the same but the formula for the SD changes to :

n

(NPV) = { t 2/(1+i)2t}1/2

i = 1

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01/01/2010 740

Quantitative aspects of projects - PERT/CPM, Network analysis for

monitoring of the project • It is well known that management of any project

involves the activities of planning, coordinating, monitoring, control and review of the performance of a number of inter-related tasks with limited resources.

• The Project Manager has also to be aware of the consequences of deviations from the initial plan – like time overruns and cost overruns.

• Therefore they look for dependable devices to achieve proper control.

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Network Techniques

• Network techniques are primarily used in project management, particularly in dealing with non-repetitive operations.

• Network techniques provide the help a manager needs, when he is defining the complex relationship that exists in sequencing and time between many jobs and planned elements of work.

• During the actual execution of the project the slippages occur.

Page 742: Project Mgt

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Network Techniques

• Network is an arrow diagram, which is a graphic representation of the project plan.

• It depicts the logical sequence of the various elements for work, in relation to each other, that must be accomplished before a project can be completed.

• A network consists of ‘events’ and ‘activities’.• Therefore it is necessary to divide the project

into clearly defined major components and to recognise the ‘events’ that mark the start and completion of each ‘activity’. ( You may recall this is nothing but the WBS).

Page 743: Project Mgt

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Network Techniques

• An ‘event’ is an occurrence at a point in time marking the commencement or completion of one or more activities.

• The symbol for an event is a circle. • Major events are marked by squares or

rectangles. • Events are numbered logically, starting from the

‘head’ events to the ‘tail’ events and are inscribed inside the circle.

• An event is said to occur when all the activities leading to it are completed.

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Network Techniques

• To put in different words, an event is : (a) the start or completion of a task; (b) a significant point or milestone in a project and (c) consumes in itself no time or resources.

• An ‘activity’ represents a clearly defined project element, work, job or task, which forms an integral part of a project and needs time and resources for carrying out.

• There are examples of activities when no work is done but they occur in between two ‘events’…………

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Network Techniques

…..– for example curing time for concrete and involves only the passage of time, or waiting for a letter of sanction for loan from a bank .

• The symbol for an activity is an arrow – the tail is the start of one activity from the previous ‘event’ and the head is the end of the activity, culminating at the next ‘event’. The length of an arrow does not represent the time taken by the activity.

Page 746: Project Mgt

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Network Techniques

• The basic rules for drawing a network are summarised below:

• Have a clear objective for which the network is required;

• Split the objective into broad areas of work (WBS);

• List the activities in a logical manner;• Plot all the activities in the sequence as decided;• Examine which activity has taken place, which is

currently going on and which is the next;

Page 747: Project Mgt

01/01/2010 747

Network Techniques

• It has a single start event and a single final event; there cannot be any loops or danglers; all the paths of the network arse continuous and proceed from left to right;

• The network plan should have a time-table of work, with each job allocated a start and finish date to ensure that the resources required to execute the job will be available when needed.

• The time each job will take to be completed has to be estimated and noted against the job in the network diagram.

Page 748: Project Mgt

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Network Techniques

• Master networks: In large projects, it is desirable to prepare a number of separate networks-for each specific level of management which reflects the degree of detail and interest to that particular level or separate networks for each individual portions of the project.

• The network for the entire project is called the Master Network.

• The end events of each separate network are integrated and shown in the master network.

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Network Techniques

• A network is not completed until the project is completed.

• Advantages of network planning:• It enables the break-up of the total project into

sets of individual jobs or events and arranges them in a logical sequence;

• It estimates the duration and resource requirements of the individual job and hence facilitates the allocation of resources;

• It identifies the trouble spot in advance and pinpoints responsibilities;

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Network Techniques

• Since the executives of all the departments participate in drawing the network, their commitment is ensured to stick to the schedules;

• In case of any change in the management team, the subsequent team can easily carry on with the project with the help of the network analysis;

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Network Techniques

• It indicates the optimum start and finish times for each activity in an operation, and allows the operations that follow a set pattern to be partly pre-planned, speeding up the final planning;

• It is an important means of training the personnel in the techniques of handling the operations;

• It allows for multi-project scheduling by computer.

Page 752: Project Mgt

01/01/2010 752

PERT

• PERT: A new family of planning and techniques has helped the development of the defence, construction, chemical and other industries.

• Some of them are: PERT, PERT/Cost, PERT/Time, CPM, CPA (Critical Path Analysis), CPS (Critical Path Scheduling) GERT ( Graphical Evaluation and Review Technique) and PERT is the best known among these techniques.

• PERT was first introduced by the US Navy for its Polaris weapon system in 1958.

Page 753: Project Mgt

01/01/2010 753

PERT

• In India, large PSUs as well as Pvt. sector giants use PERT for their projects.

• The requisites of PERT are:• The project goal needs to be clearly identified,

visualised in a logical manner and are put in a network flow diagram, comprising events and activities;

• All activity paths need to be completed by appropriate events and a description of each activity needs to be written above the arrow linking the events;

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01/01/2010 754

PERT

• Events and activities need to be sequenced so as to allow the determination of the critical paths, and all constraints and inter-dependencies should be shown in the diagram;

• The PERT network analysis consists of the following steps:

• Clearly defining the goal of the project;

Page 755: Project Mgt

01/01/2010 755

PERT

• Preparing the WBS to a set of individual jobs and arranging them in a logical fashion;

• Estimating the job duration, making provisions for optimistic and pessimistic schedules;

• Identifying the resource requirement constraints;• Locating the schedule of dates for each activity

by planning a detailed control structure;

Page 756: Project Mgt

01/01/2010 756

PERT

• Preparing project control systems, and identifying the requirements of progress reports for different levels of management;

• Developing the critical path and slack times;• Crashing the time –optimum cost levels on the

basis of costs;• Updating the network continuously by

systematised methods;• Monitoring, evaluating and reviewing the

network constantly.

Page 757: Project Mgt

01/01/2010 757

PERT

• Benefits of PERT:• PERT gives management the ability to plan the

best possible use of resources to achieve a given goal within the overall time and cost limitations;

• It helps the project manager to handle the uncertainties involved in programming where no standard time data are available;

• It utilises the time network analysis as a base method of approach to determine manpower, material, machinery and capital requirements.

Page 758: Project Mgt

01/01/2010 758

PERT

• It is an effective mechanism for planning, scheduling and co-ordinating the different activities in project buying. (Nowadays a PERT networks charts are a ‘must’ for every tender submissions to public sector projects);

• It is useful for annual shutdown and overhauls to identify the critical activities;

• It not only helps the management in deciding when to initiate the follow – up and provide materials, but also gives an estimate of the consequences of not meeting such demands;

Page 759: Project Mgt

01/01/2010 759

PERT

• It enables the optimum utilisation of the resources by their transfer from the slack to busy segments in the network in order to accomplish the stipulated goal.

• PERT is one of the most important techniques of scientific management in project planning with the minimum possible scheduling time and use of resources.

• Inefficiencies in personnel loading can be removed by the proper use of slack activities, lead time can be analysed and hence work schedules can be expedited.

Page 760: Project Mgt

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PERT

• PERT network reveals the interdependencies and problem areas which are either not obvious, or not well defined by the conventional methods;

• PERT allows a large amount of data to be presented in a systematic orderly manner and keeps the management posted up to date by the principles of exception;

• PERT has been effectively used in many areas since it offers a trade-off relationship between time, cost and performance objectives on a scientific basis.

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01/01/2010 761

PERT

• The kind of probabilistic approach adopted in PERT is useful in bidding for contracts by working out the expected performance based on experience.

• If individual activities are delayed, then the extension of time permitted can be computed.

• These computations help in the calculation of the tolerances for activity times in execution for selective management control.

Page 762: Project Mgt

01/01/2010 762

PERT

• Project duration and variation:• Project network is concerned with the control of

time. • Hence the activity time or duration associated

with each activity has to be estimated by experience, work measurement and intelligent guess.

• Three time estimates are made – the optimistic to (hope that everything will go well without any hitch – the minimum time – a very low chance of realisation in reality),…………

Page 763: Project Mgt

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PERT

• …….. the pessimistic tp (the assumption that everything will go wrong – the maximum time – a very low chance to occur in reality) , the most likely tm (not the average of to and tp but estimated from experience and intelligent guess) for each activity for the persons responsible for implementing the activity.

Page 764: Project Mgt

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PERT

• From these three time estimates, the expected time te is calculated by using the empirical formula: te = (to + 4 tm + tp )/6

• Slack and critical activities: The expected ‘elapsed time’ required to perform an activity in the network is based on the normal working conditions.

• After calculating the ‘expected time’ te for each activity, they are cumulated from the start till the end through the various paths.

Page 765: Project Mgt

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PERT

• The earliest project completion time T(E) is identified for each event as well as the final event in the PERT network.

• In computing the latest allowable time T(L),you have to work backward from the completion time for each event , and is obtained by subtracting the expected elapsed time estimate from the final goal and moving backwards through the various paths The chart is analysed by adding the estimated times. along each of the many paths, from beginning to the end of the job.

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01/01/2010 766

PERT

• In forward pass, for converging activities in junctions, we take the largest value of T(E) ; while in the backward pass in the reverse direction, for converging values, we take the smallest value T(L).

• Thus for every event, there are two values T(E) and T(L).

• Wherever these two values coincide, the commencement of that activity cannot be postponed, without introducing delay in the completion of the project.

Page 767: Project Mgt

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PERT

• This is known as ‘slack’. This positive difference gives the margin of time by which the commencement of an activity can be deliberately delayed without dislocating the duration of the project.

• The slack of an event is defined as the difference between the latest and the earliest available time to do a job and is also called the ‘float’.

• The activities that fall on the events of zero slack trace the critical path.

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PERT

• IN SHORT,THE ALGORITHM FOR LOCATING CRITICAL ACTIVITIES IS TO OBTAIN T(E) AND T(L), AND THE ACTIVITIES WITH ZERO SLACK TIME.

• The events with zero slack are identified as critical events, and the path that passes through the critical events is the critical path.

• Critical path interpretation: Slack is associated with non-critical activities. In a network, the path having the least slack is the critical path. It is also the longest path which consumes maximum time.

Page 769: Project Mgt

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PERT

• As the name suggests, each activity in the ‘critical path’ is critical, since a delay in any of the events in this path will cause the entire project to fall behind schedule, unless additional resources and personnel are made available.

• By concentrating on the critical path, the Project Manager can transfer facilities from the slack path to the critical path, in order to minimise delays.

• Zero slack indicates that the project will be completed on schedule.

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PERT - CPM

• A positive slack indicates that the project will be completed ahead of schedule and a negative slack indicates that the event is likely to slip behind the scheduled date.

• See an example in Chapter 5, Pages 36 to 38 of the book PG.

• Critical Path Method: It is a mathematically ordered system of planning and scheduling for project management, which makes possible a balanced, optimum time cost schedule and assures timeliness and minimum use of resources.

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CPM

• The method was first used by Du Pont to improve the planning , scheduling and coordinating of its new Plant construction.

• Like the PERT, this method is also based on the network principle.

• An event represents a specified programme accomplishment at a point in time, while an activity represents the time and resources required to progress from one event to another.

Page 772: Project Mgt

01/01/2010 772

CPM

• After the network diagram is established, the time and cost estimates are applied to each activity.

• With the normal estimate, the prime consideration is minimum cost with the associated time.

• As attempts will be made to reduce it later, normal time is considered as the maximum time.

• But the costs associated with normal times are assumed to the minimum costs.

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CPM

• The ‘crash’ estimate is defined as the absolute minimum time and the associated cost in relation the maximum cost.

• It is assumed that linear cost relation exists between normal and crash estimates for each activity.

• PERT uses three time estimates to arrive at the ‘expected time’ of each activity.

• The CPM user is assumed to be on less uncertain ground and to have had some prior experience with the activities comprising the project.

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CPM

• The estimates of normal and crash times are assumed to be quite specific and made with a fair degree of confidence.

• Similarly the cost estimates are also assumed to be based on a fair degree of definiteness and confidence based on prior experience.

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. The following differences may be observed between CPM and PERT:

CPM PERT Networks are ‘Activity’ oriented –

emphasises the description associated with the activities in a network.

Networks are ‘Event’ oriented -

A deterministic model – cost conscious A model under Risk – concerned with time;

Particularly useful where the decision variables can be predicted with reasonable

accuracies as in construction projects. If the most likely time is known, then it may be

used a deterministic value

The time for one or more activities follow a probability distribution; takes into account the uncertainties.

Page 776: Project Mgt

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CPM

• Assumptions of PERT and CPM:• Both assume that the project is definable by

activities that have distinct beginning and ending points.

• Construction of CPM: The basic steps involved are:

• Break the entire project into smaller systems, known as tasks;

• For each task, determine the activities and events to be performed;

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CPM

• For each activity, determine the preceding and succeeding activities;

• For each activity, determine the time and other resources needed;

• Draw a network plan depicting the assembly as discussed in the previous chapter, considering only the expected time estimate. Events are represented by circles called ‘ nodes’.

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CPM

• Ground rules for construction of the CPM are: An event cannot occur until all the activities leading to it are completed and an activity cannot start until its preceding event has occurred;

• An event can occur only once; • The time flow is from left to right; • The earliest occurrence time of the initial event

is set to zero, and we proceed through the diagram ;

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CPM

• The earliest occurrence time can be calculated only if the preceding events’ earliest occurrence times are calculated; the earliest and latest occurrence times are plotted in the chart.

• The arrow diagram is common to both PERT and CPM; THE DIFFERENCE LIES IN THE DATA ENTERED ON THE DIAGRAM.

• An activity can start only when all the preceding activities have been completed.

• Therefore, the earliest occurrence time of an activity is precisely the earliest occurrence of the predecessor event.

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CPM

• The start time of an activity plus its activity duration gives its finish time.

• Thus, the earliest finish times of activities are the earliest start times of the activities plus their duration.

• The latest finish time of an activity is precisely the latest occurrence time of its successor event, a later finish would delay the project

• The finish time of an activity minus its activity duration gives its start time.

• Thus the latest start times of activities are the finish times of activities which require the greatest normal time.

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CPM

• The critical path is that sequence of activities which require the greatest normal time to accomplish.

• Based on the normal times for each activity, earliest start dates are computed for all activities along any path by working forward from the beginning of the path activity in the path.

• Similarly, the latest finish date and earliest finish date for all activities in a given path are computed.

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CPM

• It may be mentioned that sufficient leeway is possible for any path other than critical.

• Events with zero slack are known as critical events and the path that traverses through critical events is the critical path.

• Non critical activities can be increased in duration, since there is time to spare to complete these activities but without exceeding the critical path time.

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CPM

• Float calculation: ‘Free Float’ is the maximum time slippage of an activity that can be tolerated without affecting the completion date of any other activity in the situation where both the preceding and succeeding activities are assumed to start at the earliest possible times.

• THE FLOAT OF THE ACTIVITIES IS THE DIFFERENCE BETWEEN EITHER THE LATEST START AND EARLIEST START OR BETWEEN THE LATEST FINISH AND THE EARLIEST FINISH.

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CPM

• The ‘Total Float’ is the maximum slippage of an activity or the spare time that can be tolerated without affecting the completion date of the overall project.

• Here the assumption is that all the preceding activities start as early as possible and all succeeding activities start as late as possible.

• THE DIFFERENCE BETWEEN THE START AND COMPLETE EVENTS OF THE ACTIVITIES IS THE TOTAL FLOAT.

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CPM

• ‘Independent Float’ is the maximum slippage of an activity that can be tolerated without affecting the latest completion date of any other activity under the situation where all preceding activities are completed as late as possible and all succeeding activities are started as early as possible.

• The duration of an activity with independent float can be increased by the amount of float without affecting the progress of the succeeding activities, or the float available to preceding activities.

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CPM

• IT IS CALCULATED BY DEDUCTING THE LATEST EVENT TIME OF START EVENT AND DURATION OF ACTIVITY FROM THE EARLIEST EVENT TIME AND END EVENT FOR ANY ACTIVITY.

• Free Float is the duration by which the float of an activity can be increased without affecting the progress of succeeding activities.

• This will reduce the amount of total float available for preceding activities. Free float occurs only in the last of a series of activities leading to a critical path.

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CPM

• Critical Path and Management Decisions:• The activities for which positive slack time is

available can be performed at a slower pace, thereby releasing some of the resources for use in the critical activities, provided the activities are interchangeable.

• Total duration of the project can be reduced only by reducing the duration of the activities on the critical path.

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CPM

• When a project network is executed and one or more time estimates, change, the entire network may have to be reconstructed and the new path of critical activities identified.

• Slack is the difference between the latest event time and the earliest event time for a particular event.

• Total Float ={T(L) of succeeding event minus T(E) of the preceding event} – t(e);

• Free Float ={T(E) of succeeding event minus T(E) of the preceding event} – t(e);

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CPM

• Independent Float = {T(E) of succeeding event minus T(L) of preceding event}- t(e) ; (If negative, the Independent Float is taken as zero.),

• Where t(e) is the ‘Expected Activity Time’, T(E) is the ‘Earliest Event Time (the earliest time an event can occur), T(L) is the ‘Latest Event Time ( (latest possible time at which an activity can start )

• “Interference Float’ is the difference between total float and free float.

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CPM

• ‘Resource Levelling’ is the scheduling of activity start times such that resource levels are kept at the minimum possible;

• “Resource Smoothing’ is the scheduling of activity start times within the limits of their total floats, such that the targeted project duration is maintained and fluctuation in resource requirements are minimised;

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CPM

• ‘Crashing’ is the process of advancing the completion date of the project to suit a revised and reduced project duration by reducing the duration of one or more activities on critical path.

• This is also known as ‘activity compression’;• ‘Activity Crash Time’ is the revised and reduced

activity time; • ‘Crash Cost’ is the increase cost of crashing a

project;

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CPM

• ‘Cost Slope’ is the additional cost to be incurred in reducing an activity time per unit time.

• Compression on Critical Path:• Need for crashing: The duration for the project

completion as planned by the project manager may be more than that stipulated by the management. In that case, it would be necessary to have a re-look at the network.

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CPM

• The time-cost trade-off or crashing the network is directed to the cost of determining a schedule of project activities which considers adequately the indirect as well as the direct costs.

• The total time can be reduced by ‘crashing’, ‘compressing’ or ‘completing’ the critical activities in less time.

• Obviously this will involve a higher cost than would be incurred when performing at the original rate.

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CPM

• Compression is achieved by:• Closer examination of the time estimates of the

critical activities;• Introducing greater paralleling i.e. more

concurrent activities and or changing or lowering performance requirements of certain activities;

• Dropping off low priority activities, as a last resort,

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CPM

• Transfer or reallocation of slack resources if possible, from non critical activities to activities on the critical oath;

• Addition of more resources to the critical path, and crashing other activities.

• It should be noted that time and cost are inversely correlated.

• Due to technological constraints, any activity will have a minimum time requirement, below which it cannot be reduced further.

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CPM

• For example, duration of construction activity cannot be reduced below a certain limit due to constraints like time taken for curing of concrete etc.

• The activity will have a normal time requirement. In between these two limits, the time required can be reduced by deploying additional resources/money.

• This procedure is known as ‘crashing’ and the extra cost incurred is the ‘crashing cost’.

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CPM

• The usual practice is to crash the initial activities on the critical path.

• The activity with the lowest slope is chosen for crashing.

• After a few such steps of crashing, more than one path may be come critical.

• This implies that a new schedule with increased cost but with less time is obtained.

• The additional cost and benefit have to be reviewed at each stage of crashing-direct, indirect and opportunity cost are included in the total cost.

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CPM

• The opportunity cost is the penalty for not accomplishing the job in time.

• The extra cost per unit of time = (Crash Cost- Normal Cost)/(Crash time – Normal time). = cost slope.

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CPM

• Looking though the critical path and the cost slope, the activity with the smallest slope has to be crashed.

• The time – cost relationship helps the manager to determine when diminishing returns make further time saving uneconomical.

• As long as the extra cost incurred in crashing is commensurate with benefits, it is worthwhile crashing the activities, and thereby reducing not only the time of the project without incurring a total extra cost, but also quite often the total cost itself.

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Let us see an example:

Time Estimate Activity Numerical Description Optimistic to Most Likely

tm Pessimistic

tp Average

te = (to + 4tm + tp)/6

a 1 – 2 9 12 21 13 b 1 – 3 6 12 18 12 c 2 – 4 1 1.5 5 2 d 3 – 4 4 8.5 10 8 e 2 – 5 10 14 24 15 f 3 - 5 1 2 3 2

Page 801: Project Mgt

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The net work diagram would be as follows:

3

1

2

4

5

13

12

8

2

15

2

Page 802: Project Mgt

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Earliest Occurrence Time for Each event (EOT), Latest Occurrence of Each Event (LOT) and Slack :

Event

EOT of event

(Forward Pass)

LOT of event

(Backward Pass)

Slack =

LOT-EOT

5 28 28 0 4 20 26 6 3 12 18 6 2 13 13 0 1 0 0 0

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CPM

• The paths 2 – 4 and 1 – 3 are slack paths each having a slack of 6 and so cushion.

• The path 1 – 2 -5 which does not have any slack is the critical path.

• The minimum required time to complete the project is the duration of the critical path which is 28.

Page 804: Project Mgt

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The net work diagram would be as follows when the EOT/LOT are incorporated in it. in the box showing the event no;:

1 –0/0

2 – 13/13

5 – 28/28

13

12 2

15

2

3 – 12/18 8 4 – 20/26

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CPM

• Activity Floats: Once you know the activity times and the event slacks, activity floats can be calculated.

• In the above example, for the activity 2 – 4, the Total float :

= LOT (4) – EOT(2) – te (2-4) = 26 – 13 -2 = 11;

• The Free float : = EOT (4) – EOT ( 2) - te (2-4) =

20 – 13 – 2 = 5;

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CPM

• And the Independent float:= EOT (4) – LOT (2) - te (2-4) = 20 -13 – 2 = 11.

• Similarly the total, free and independent floats for the activity 3 -4 are: 6, 0 and -6.

• Similarly the floats for the other activities can also be found out.

• You will observe that all the floats are zeroes for the activities along the critical path. (Activities 1 – 2 and 2 – 5 in the above example.)

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CPM

• The independent float represents the float under the most adverse conditions.

• Hence when an activity has a positive independent float, it means that the activity has a cushion irrespective of what happens elsewhere.

• However, the independent float of an activity may be negative but the total float and free float cannot be negative.

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CPM

• Measures of variability:• Variability in PERT analysis is measured by

variance or SD.• The steps involved calculating the SD of the

duration of critical path are as follows:• Determine the SD of the duration of each activity

on the critical path;• Determine the SD of the total duration of the

critical path on the basis of info obtained in the previous step;

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CPM

• For determining the SD of the duration of an activity, we require the entire probability distribution of the activity distribution. But we have only three values from this distribution viz. to, tm and tp. In PERT analysis a simplified formula for Standard Deviation is used which is : = (tp - to)/6.

Page 810: Project Mgt

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For the example , the and variance of the activities along the critical path are as follows: Activity tp to = (tp - to)/6.

Variance = 2

1 – 2 21 9 2 4 2 – 5 24 10 2.33 5.43

Variance of the critical path duration = Sum of variances of activity durations on the critical path = 9.43; SD of the critical path duration = √9.43 = 3.07. Thus we have found that the mean and SD of the duration of the activities on the critical path are 28 days and 3.07 days.

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CPM

• For real life projects, which have a large number of activities on the critical path, we can reasonably assume that the critical path duration is approximately normally distributed, with the mean and SD obtained as shown earlier.

• A normal distribution looks like a bell shaped curve, is symmetric, is single peaked and is fully described by its mean and SD.

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CPM

• The probability of values lying within certain ranges is as follows:

• Range: Mean ± One SD : Probability : 0.682;

Mean ± Two SDs: :0.954; and

Mean ± Three SDs : 0.998.

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CPM

• Probability of completion of a project by a specific date:

• If we have the mean (T), and SD for critical path duration, which is normally distributed, we can compute the probability of completion by a specified date (D) as follows: – Find Z = (D – T) / , where Z represents the

no. of SDs by which D, the specified date exceeds T.

– Obtain cumulative probability up to Z by looking at the probability distribution of the standard normal variate.

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CPM

– (Determining Z is equivalent to converting our specific normal distribution into standard normal distribution.

– The mean and SD of standard normal distribution are 0 and 1 respectively.)

Page 815: Project Mgt

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Now let us calculate the probability of completion of the project in 20, 25 and 30 days. We know the mean and .

Specified Date, D Z Probability of completion by D:

20 (20 -28)/3.07 ≈-2.6 0.005 25 (25 -28)/.07 ≈ -1.0 0.159 30 (30 -28)/3.07≈0.6 0.726

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CPM

• Crashing of cost in CPM:• CPM analysis assumes that ●The costs

associated with the project can be divided into direct costs (direct material, direct labour…)and indirect costs ( Overhead items like indirect supplies, rent insurance, managerial services….,) ● Activities of a project can be expedited by crashing which involves employing more resources, ● Crashing reduces time but increases direct costs because of factors like overtime payments, etc. and decreases indirect costs.

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CPM

• The CPM analysis seeks to find ways of crashing on total cost (= direct costs + indirect costs) and also reduce the project duration.

• The procedure for this as follows:• Obtain the critical path in the normal network and

determine the project duration and direct cost;• Examine the cost –time slope of activities on the

critical path and crash the activity which has the lest slope;

• Construct the new critical path after crashing as above and determine project duration and cost;

• Repeat the two previous steps till activities on the critical path are crashed.

Page 818: Project Mgt

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One example will clarify: Normal and Crash time and Cost:

Time in weeks Cost Activity

Normal Crash Normal Rs. Crash Rs.

Cost to expedite, per week

1 – 2 8 4 3000 6000 750 1 – 3 5 3 4000 8000 2000 2 – 4 9 6 4000 5500 500 3 – 5 7 5 2000 3200 600 2 – 5 5 1 8000 12000 1000 4 – 6 3 2 ½ 10000 11200 2400 5 – 6 6 2 4000 6800 700 6 – 7 10 7 6000 8700 900 5 – 7 9 5 4200 9000 1200

45200 70400

Page 819: Project Mgt

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The Project Net work: 2 4 6

1 7 3 5 The Critical path is 1 – 2 – 4 – 6 – 7, the duration is 30 days and the direct cost is .Rs. 45200.

7

9 5

8

9 3

10

5 6

Page 820: Project Mgt

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From the table, we can see that the activity 2 – 4 has the lowest slope in the critical path and hence that activity is crashed by 3 weeks, thereby reducing the duration to 27 weeks. Now the changed network will look as follows:

2 4 6

1 7 3 5 The direct cost has increased to Rs.46700.

7

9 5

8

6 3

10

5 6

Page 821: Project Mgt

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Now the new Critical path is 1 – 2 – 5 -6 – 7 with duration 29 weeks and the cost is Rs. Rs.46700. Now the activity with the lowest slope is 5 – 6 and by crashing that , the direct cost has gone up by Rs.2800 to Rs. 49500, but the duration is reduced by 4 weeks to 25 weeks. So the network diagram now changes to :

2 4 6

1 7 3 5

7

9 5

8

6 3

10

5 2

Page 822: Project Mgt

01/01/2010 822

Now, the new critical path is 1 -2 - 4 -6 -7 with the duration 27 weeks and direct cost Rs. 49500. At this stage, activity 1 – 2 has the least slope and so that activity has to be crashed by 4 weeks, thereby reducing the duration to 23 weeks and increasing by the direct cost by Rs. 3000 to Rs. 52500. Now the network will change to :

2 4 6

1 7 3 5 7

9 5

4

6 3

10

5 2

Page 823: Project Mgt

01/01/2010 823

And the new critical path is : 1 – 3 – 5 – 6 – 7 with duration 24 weeks and direct cost Rs. 52500. You can see that the activity 3 – 5 in the critical path has the least slope and by crashing the duration is reduced by 2 weeks to 22 weeks and the direct cost increases by Rs.1200 to Rs. 53700. So the diagram changes to

2 4 6

1 7 3 5 5

9 5

4

6 3

107

5 2

Page 824: Project Mgt

01/01/2010 824

Now again the path 1 – 2 – 4 – 6 – 7 has become critical with duration23 weeks and direct cost Rs.53700. Now by crashing activity 6 – 7, we can reduce the duration by 3 weeks to 20 by increasing the direct cost by Rs. 2700 to Rs.56400. The new critical path is shown below.

2 4 6

1 7 3 5

5

9 5

4

6 3

7

5 2

Page 825: Project Mgt

01/01/2010 825

Now the critical path is 1 – 2 – 4 – 6 -7 with duration 20 weeks and direct cost Rs. 56400. Now the activity 4 – 6 can be crashed, resulting in reducing the duration by ½ week to 19 ½ weeks and increasing the direct cost by Rs. 1200 to Rs. 57600. The new critical path is shown below.

2 4 6

1 7 3 5 5

9 5

4

6 2.5

7

5 2

Page 826: Project Mgt

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CPM

• We have now reached the final stage, where the path 1 – 2 – 4 – 6 – 7 continues to be the critical path with duration 19 ½ weeks and direct cost Rs. 57600.

• You may observe that there is no more activity left for crashing.

• In the final analysis, due to crashing of some activities along the critical paths, the duration has come to 19.5 weeks, the direct cost has gone up to Rs. 57600 and the indirect cost has come down to Rs. 39000 (from Rs. 60000).

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CPM

• So the total cost has come down to Rs. 57600 + 39000 = Rs. 96600 ( from Rs. 45200 + 60000 i.e. 105200 .

Page 828: Project Mgt

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Computer Applications in Project

Management • The computer has now become a part of project

decision-making process. It has revolutionised the working of the industrial and project management all over the world.

• A lot of work has taken place on computer software. The softwares that are available nowadays are user friendly .

• A number of computer ‘languages’ have been developed based on the needs of the users.

• A lot of ‘Application Packages’ have also been developed.

• In projects, which are generally complex, lapses go easily go unnoticed and as a result, wrong decisions are made.

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Computer Applications in Project

Management • Computers can help to avoid such pitfalls in all fields

of management. • On any project with many activities, with

frequent updating, the computer cost will be equal to the manual cost, but the speed, reliability, versatility, Memory, accuracy and other facilities will far outweigh the manual process. Communication of the project strategy can be common with one control document seen by all.

• Project managers have to deal with uncertainties and risks while scheduling activities and allocating resources. In such cases, they have to seek the probabilistic approaches.

Page 830: Project Mgt

01/01/2010 830

Computer Applications in Project

Management • For example, the probabilistic aspect of critical-

path methods deals with the fact that the actual duration of a project activity is usually a random variable rather than a deterministic constant.

• Similar is the case with certain milestone events where probabilistic branching of certain activities to reach such events, should be considered.

• The Computer can aid the project management by providing quick analysed info in any required form, by doing the routine numerical problems at great speed.

Page 831: Project Mgt

01/01/2010 831

Computer Applications in Project

Management • In project management, in addition to the routine

info about the activities, activity schedules, activity timings, key activities, the computer can give detailed info about :

critical activities, critical events, earliest and latest start and finishing times

of activities, critical path, slack, bar charts of various departments, optimum time/cost, allocation of resources, multi project schedules, simulated PERT, bills outstanding, location of equipment, financial info, marketing info, key ratios etc.

Page 832: Project Mgt

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Computer Applications in Project

Management • The revolution in computer has made project

management systems affordable and amenable to projects of all sizes.

• After the microcomputers have been widely adopted by the business community, abundant project management software packages are now available.

• The software programmes support the planning and control of such elements as work scope, contents of a project, project timing, human resources, budgeting, costs and communications. They also compare the current status to the plan and so helpful in monitoring the progress of the project and its evaluation.

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Computer Applications in Project

Management • Most of the WBS in project planning is now down by

the computer. • The computer can support the project manager to

support the budgets task by task or by cost categories, to plot the expenditure schedules and cash flow plans.

• With the help of computers, one can reorganise the activities, reschedule the tasks and do resource planning in an iterative process to optimise the schedule and resource plan.

• Tracking through the computer enables the recording of how much work has been done, what resources were utilised and what costs were incurred.

Page 834: Project Mgt

01/01/2010 834

Computer Applications in Project

Management • Artificial intelligence Expert System:• Artificial Intelligence (AI) programmes involve

symbolic representation, symbolic inference, and heuristic search.

• A new area of AI which is of particular interest to project management is known as ‘Expert System’.

• An expert system is software that attempts to reproduce the performance of one or more human experts, most commonly in a specific problem domain, and is a traditional application and/or subfield of artificial intelligence.

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Computer Applications in Project

Management • These programmes seek to solve practical

problems by imitating the process human experts would follow.

• They can achieve a high level of performance in tasks where human beings require years of special education and experience.

• An expert system is also capable of drawing conclusions without a predefined structure.

• It could perform the following functions:• Monitor deviations from the planned schedule,

progress and analyse interrelations among the various packages.

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Computer Applications in Project

Management • Identify single potential schedule slippages. The

system would extrapolate effects of changes in status, identify the affected items and classify them in order of criticality.

• Pinpoint the needs for human intervention and analysis.

• The AI based system would attempt to take decisions on the basis of incomplete data, but the expert system would identify the need for data and show where human intervention would be most effective.

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Computer Applications in Project

Management • Show where to allocate special resources and

reserves. • The system would extend schedule findings to

cost-to-complete by tracking cost factors associated with work-packages. (A delay in one would increase the cost of a later one.)

• Improve resource utilisation. • The system would not only focus on the most

critical activities but would also point out previously critical activities, which should be relieved from the earlier imposed management pressures or extra resources.

Page 838: Project Mgt

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Computer Applications in Project

Management • Alternative resource schedules would be proposed

automatically and presented to the management for decision.

• Multi-Project Scheduling: When several projects are progressing simultaneously, computers are very helpful in scheduling and allocating the resources among the projects since the resources may be drawn from the same common pool.

• Optimisation of the utilisation of resources is achieved through the use of computers. The resources in question may be skilled manpower, staff, equipment, funds etc. which have to be managed along many dimensions such as costs, time and returns.

Page 839: Project Mgt

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Computer Applications in Project

Management • Global projects, organised on a matrix basis can

be simulated to study the behaviour of client, contractor, supplier, consultant, architect, subcontractor, vendor, local project authorities, local regulations, fund availability, coordination, planning, control, monitoring, evaluation and integrate the same from the organisation’s priorities.

• Computer PERT simulation:• Simulation is very helpful in Project Management

especially in project planning through network analysis for new product launching.

Page 840: Project Mgt

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Computer Applications in Project

Management • Simulation is a quantitative technique used for

studying alternative course of action by building a model of that system and then conducting a series of repeated trials to predict the behaviour of a system over a period of time. The desired changes in system can be introduced for studying their effects.

• Simulation can be used for evaluating capital investment proposals by varying factors such as market size, selling price, market growth rate, market share, investment required, residual value of investment, operating cost, fixed cost, useful life of facilities etc.

Page 841: Project Mgt

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Computer Applications in Project

Management • By simulating the network several times, each

time randomly selecting an activity time from within its estimated ranges for each activity, simulation enables the probability of an activity being on critical path in advance and this helps in allocating the resources in a better fashion.

• The accuracy of PERT simulation is more than that of PERT. Random numbers generated by the computer, which have equal chance of representation in the sample are used to simulate a sample.

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Computer Applications in Project Management

• Project Managers are often faced with considerable project uncertainties and risks and they arise due to external factors (such as government regulations, difficulties in financing etc.) and internal factors ( site-location problems, design alternatives etc.).

• There are also other constraints like technological considerations. Network models provide the means to model these types of uncertainties.

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Computer Applications in Project Management

• In particular, the computer network simulation languages such as Q-GERT, and SLAM provide the concepts of probabilistic and conditional branching, random activity times, and different nodal release requirements for this purpose.

• This represents a significant modelling improvement beyond the capabilities of PERT and CPM type networks.

Page 844: Project Mgt

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Computer Applications in Project Management

• Project Management Softwares: • These are used in time critical allocations. A

multiplicity of project management software is available today - each with varying approach of performing certain basic functions of project planning, scheduling, monitoring, control and review.

• Now there are many project management software packages available in India – some of the well known are :PRISM, INSTAPLAN, PC-Projaks, Proman, Harward Total Project Manager, Quick Net.

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Computer Applications in Project Management

• There are also other packages such as: Artemis project, MAC project, Microtrak, plotrak, PERT master, plantrak, primavision, PROB-PERt, promis, super project expert, timeline, etc.

• At least 25 names of Project Softwares have been listed in Wikipedia.

• Infogoal.com has the list of more than 400 Project Management Softwares.

• (See the information about some of the softwares presently available in the Notes)