Module 1

This module gives an overview of project planning and analysis, and capital budgeting. It is divided into five sections, namely

Capital expenditures: importance and difficulties

Phases of capital budgeting Generation and screening of project ideas Facets of project analysis Resource allocation framework

Capital expenditure are those expenditure which are capital in nature

The following are the importance of capital expenditure:

They have long term effect Irreversible in nature Substantial outlays involved

The following are the difficulty involved in capital expenditure decisions:

o Measurement problems

o Uncertainty

o Temporal spread

Capital budgeting is a complex process which may be divided into five phases:

Planning

Analysis

Selection

Implementation

Review

Planning

Articulation of firms broad investment strategy

type of investment

identification of individual project opportunities

Generation and screening of project proposals

Prima facie worthwhile to justify feasibility study

what aspects of project are critical to study

Analysis

A detailed analysis of the marketing, technical, financial, economical, and ecological aspects

Focuses on gathering, preparing and summarizing relevant information

The stream of cost and benefits can be defined

Selection

Is the project worthwhile? Wide range of appraisal criteria is

used to judge the worthiness of a project

Such criteria are divided into non-discounting and discounting technique

Implementation

Refers to conversion of blue print into reality In case of industrial project, implementation involves setting

of manufacturing facilities Project and engineering design Negotiations and contracting Construction Training Plant commissioning (starting up the plant) Translating an investment proposal into a concrete project is

a complex, time-consuming and risky task For expeditious implementation at a reasonable cost, the

following are helpful: Adequate formulation of Project Use of the principles of Responsibility Accounting Use of Network Techniques

Review

Performance review should be done periodically to compare actual performance with the projected performance

Feedback device is useful in in several way: how realistic were the assumptions

provides a documented log of experience that is

highly valuable in future decision making suggests corrective action to be taken in the light of

actual performance helps in uncovering judgemental biases induces a desired caution among project sponsors

Generation and screening of project ideas

Generation of ideas Monitoring the environment Corporate appraisal Scouting for project ideas Preliminary screening

Generation of project ideas

The search of promising ideas is the 1st step towards establishing a successful venture

The key success of any venture is getting the right idea at right time

Identification of such opportunities requires imagination, sensitivity to environmental changes, and realistic assessment of what the firm can do

significant technological breakthroughs, combining existing fields of technology or offering variants of present products or services, periodic SOWT analysis, fostering conductive organizational climate to tap the creativity of employee facilitates the generation of ideas

Monitoring the Environment

Promising investment idea enables a firm/entrepreneur to exploit opportunities in the environment

For the purpose of monitoring, business environment may be divided into:

1. Economic sector 2. Governmental sector 3. Technological sector 4. Socio-demographic sector 5. Competition 6. Supplier sector

Economic sector

State of the economy Overall rate of growth Cyclical fluctuations Inflation rate Linkage with the world economy Trade surplus/deficits Balance of payment situation

Governmental sector

Industrial policy Government programmes and projects Tax framework Subsidies, incentives and concessions Import and export policies Financing norms Lending conditions of financial institutions and commercial banks

Technological sector

Emergence of new technologies Access to technical know-how,

foreign as well as indigenous Receptiveness on the part of

industry

Socio-demographic sector

Population trends Age shifts in population Income distribution Educational profile Employment of women Attitude towards consumption and

investment

Competition

Number of firms in the industry and their market share (of the top five or four)

Degree of homogeneity and differentiation among products

Entry barriers Comparison with substitutes Marketing policies and practices

Supplier sector

Availability and costs of raw-materials and sub-assemblies

Availability and costs energy Availability and costs of money

Corporate appraisal

A realistic appraisal of corporate strengths and weakness is essential for identification of investment opportunities which can be profitably exploited

The broad areas of corporate appraisals are:

1. Marketing and Distribution 2. Production and Operations 3. Research and Development 4. Corporate Resources and Personnel 5. Finance and Accounting

Marketing and Distribution

Market image Product line Market share Distribution network Customer loyalty Marketing and distribution costs

Production and Operations

Condition and capacity of plant and machinery

Availability of raw materials, sub-assemblies, and power

Degree of vertical integration Locational advantage Cost structure

Research and Development

Research facilities, laboratories and equipment, modeling and testing facilities

Capability of the firm to invest in R&D Presence of well known researchers and

scientists Track record of new product

developments Coordination between research and

operations

Corporate resources and personnel

Corporate image Clout with governmental and

regulatory agencies Dynamism of top management Competence and commitment of

employees State of industrial relations

Finance and Accounting

Financial leverage and borrowing capacity

Cost of capital Tax situation Relations with shareholders and

creditors Accounting and control system

cash flows and liquidity

Scouting for project ideas

Project managers perform numerous activities to generate more and more project ideas

Some suggestions are: Analyze the performance of existing industries Observe the inputs and outputs of various industries Analysis of Exports and Imports Study plan outlays and Government guidelines look at the suggestions of Financial and Development

agencies Study social and economic trends Study new technological developments Explore the possibility of reviving sick units Identify unfulfilled psychological needs Attend trade fairs

Preliminary Screening

After a pool of ideas are generated the project manager starts to screen them initially

Some kind of preliminary screening is required to eliminate ideas which prima facie are not promising

Preliminary screening is a process of rejection rather than a process of selection

The following aspects may be looked into: Compatibility with the promoter Consistency with Government Priorities Availability of inputs Adequacy of market demand Reasonableness of cost Acceptable risk level

Compatibility with the Promoter

Project idea must be compatible with the interest, personality and resources of entrepreneur

According to Murphy, a real opportunity has three characteristics:

1. It fits the personality of the entrepreneur

3. It is accessible to him 2. It offers him the prospect of rapid

growth and high return on invested capital

Consistency with Government Priorities

The project ideas must be feasible given the national goals and government regulatory framework

The following question may raised in this context: Is the project consistent with national goals and

priorities? Are there any environmental effects contrary to

governmental regulations? Can the foreign exchange requirements of the

project be easily accommodated? Will there be any difficulty in obtaining the

license for the project?

Availability of Inputs

The following questions are needed to be answered:

Are the capital requirements of the project within manageable limits?

Can the technical know-how required for the project be obtained?

Are the raw materials required for the project available domestically at a reasonable cost? If the raw materials have to be imported, will there be problems?

Is the power supply for the project reasonably obtained from external sources and captive power sources?

Acceptability of Risk level

A project is critically dependent on the risk characterizing it

The assessment of risk is a difficult task, and the following factors should be considered:

Vulnerability to business cycle Technological changes Competition from substitutes Competition from imports Governmental control over price and

distribution

Project Rating Index

Is an evaluation method that helps management to carry out the process of preliminary screening

In this method, management identifies factors for rating projects and assigns a weight to each factor. The projects are then measured against these factors and assigned a score. If the project gets the score below the desired value the project is rejected.

Construction of Rating Index

Factors Factor Weight

Rating FactorScoreVG-5 G-4 A-3 P-2 VP-1

Technical know-how

0.25 √ 0.75

Adequacy of market 0.15 √ 0.45

Input Availability 0.10 √ 0.40

Consistency withGovt. policies

0.20 √ 0.80

Reasonableness of cost of raw materials

0.30 √ 0.60

Rating Index 3.00

Source of Positive Net Present Value

Project managers prefers to select project ideas that give higher returns than the investment made

The net present value is defined as the present value of the future revenues minus future costs

Sometimes sources of positive net present value acts as entry barriers. Hence, an understanding of entry barriers is helpful in identifying positive net present value

There six main entry barriers that result in positive NPV projects, namely:

1. Economies of scale 2. Product differentiation 3. Cost advantage 4. Marketing reach 5. Technological edge 6. Government policy