Chapter 1: Project

Introduction
`
 Project definition
• A project is time-framed efforts which is within a program as an undertaking
with a scheduled beginning and end and which normally involves some
primary purpose.

• A project is any new structure, process or system, the repair or rehabilitation

of an existing one. A series of interrelated actions that lead to a defined
objective. An investment of resources leading to that goal.
 Project within a system
Family tree of a project
• System (Plan)
• Program
• Project
• Package
• Task/Sub task
• Activities
Project Characteristics
• Specific objectives and goals
Projects are meant to fulfil certain objectives and goal of a programme or a plan.

• A time frame for completion

a project is not a continuous process. It must have a start and a finish date.

• Temporary Organisation and team

Project being of temporary existence with certain start and finish date, the organization and team who are responsible for the completion of a project
is also of temporary nature. The team composition will also be different at different stages of a project and after the completion of the project the team has to
disperse if there is no other project of similar nature.

• Rapid expenditure
projects come up in the form of investment for better return. Hence, the level of expenditure is very high compared to the plan or program of
permanent nature.

• Demanding time scale

The objectives and goals to be fulfilled by a project can be better materialized if the project is ready in all respect for operation, within certain date
fixed at the very initial stage of a project. Hence, the duration of a project is fixed and the job is to be completed within that time frame may need a very tight
work schedule.

• An involvement of several people and numerous collaborating organization

suppliers, designers, contractors, experts of different discipline etc.
 Project characteristics

• A limited set of resources – 4M (material, money, manpower and machine)

• Uncertainty and financial risks
• No benefit for a client until project is in operation
• Sequencing of activities and phases.
• Changes during implementation
• High level of subcontracting
• Uniqueness – no two projects are
 Project Classification
Funding
• Private sector project
• Government sector project
• Grant projects
• Loan projects
• Local resources Projects
• Foreign aided project
• Joint venture project
• Bilateral project
• Multilateral project
 Project Classification
• Techniques
• Labor intensive project
• Capital intensive project
• Functions
• Disaster prevention projects
• Development projects
• Service sector projects
• Environment friendly projects etc.
• Orientation
• Product oriented
• Process oriented
 Project Classification
• Scale and size
• Mega
• Major
• Medium
• Small
• Nature of project
• Simple
• Complex
• Innovative
• Emergency
• Time frame and speed
• Normal
• Crash
• Emergency relief
 Project objectives and goal
The time spent on setting goals would pay off through project success.
Goals are purpose and mission for initiating a project.
• Goal setting is:
• To fix a target
• to create commitment and agreement about the goal
When to set goals?, and for whom?
Goals are to be set;
• At the start of a project
• At the start of next phase of planning
 Project objectives and goal
Goals are to be SMART
S- Specific i.e. well defined and clear
M- Measurable. Should be able to measure during implementation. Some goals are easy to measure and
some are difficult.
A- Agreed upon by the team members. Agreed goals raise the sense of commitment and are easy to
implement and change, if necessary.
R- Realistic. Possible under given resources, experience, knowledge and time available.
T- Time framed. A start and a deadline.
Develop the project goal and make sure it is clear and SMART.
Communicate it to all team members and keep the goal constantly out in front of concerned people.
 Objectives of project
Objectives:
• Objectives resembles the goal. While selecting the objectives SMART criteria is equally valid, but with clear
division of responsibility of each member in the team. Objective defines the role of each team member’s
contribution to the overall project goal. Goal and objectives are interchangeable terms.

Problems associated with setting goals and objectives

• To much of detail or too less information

• Reward/control system – people do what manager inspects and not what the manager expects.
• More responsibility but not enough authority or vice versa
Project phases, project life cycle

Major project phases:

• Development planning – company and market strategy
• Feasibility study – design options and cases
• Conceptual study – case selection and optimization
• Project planning – project execution and contract planning, work scope definition
• Design and procurement
• Construction
• Commission and start up
• Defects Liability Period – warranty period
 Project Phases
The above phases can be divided into four major phases

• Formulation (conceptual) phase

• Development planning phase
• Implementation phase
• Termination phase
 Overall project cash flow
investment Return
cost

Breakeven

sanction

conceive completion
 Project life cycle
• Demand
• Identification
• Feasibility studies and appraisal
• Negotiation and sanctions
• Design
• Implementation – construction
• Commission
• Operation
• Monitoring and evaluation
• Decommission
 Project Environment
The project environment is made up of internal and external factors that
influence a project. When managing a project, the project manager must
consider more than just the project itself. Proactively managing a project
involves understanding the environment in which the project must function.
• Internal – Project Team (roles and responsibility) and project owner
• External – end users, customers, social groups, suppliers (manage –
communicate benefit, involve in planning, identify need and expectations and
try to meet them)
Project Management –
introduction of the subject

Prepared and Presented by:

Prof. Khem Dallakoti
What is management?
 Management is getting things done from others effectively
 Management ?
 A science or
 An art
 What we manage in engineering projects? 3Ms to achieve
 Timely completion of project
 Cost within the budget
 Desired Quality and in
 Good project Environment
Management ?
Money make things possible,
people make things happen

We are not to create fire fighting managers or crisis

manager
but
fire avoiding manager or crisis avoiding manager
Management functions
How to become effective manager?
 Planning

 Doing project in the mind before it is done in the

field
 Planning for effective use of 3Ms (Manpower,

Material, Machine) – types of planning – time,

equipment, material, HR, logistic, financial,
 Use of Planning tools

 Plan the work and work the plan

Management functions
How to become effective manager ?
 Monitoring
 Mechanism to check whether things are happening as per plan or not
 Inspection
 Supervision
 Surveillance
 Revision in objectives in responding unexpected events
 Controlling
 Intervention by the manager for remedy
 Course of action to be taken to bring the project in the track
 Actions to be as per plan
Management function
How to become effective manager?
 Coordination – mechanism to communicate the output of
planning, monitoring and controlling.
 Organizing and staffing
 Organizational structure – functional, matrix etc
 Hiring and firing of staff
 Directing, participating, facilitating, delegating
 Motivation etc
Course content
 Introduction of Project Management – management thoughts and Role of
project manager
 Quality management and reliability
 Motivation
 Leadership
 Contract management
 Safety in construction
 Value Management
 Risk Management



Chapter 2: Project Appraisal and Formulation
Concept of project appraisal
Project proposal (technical and financial)
Procedures for developing project proposal
Techniques of project formulation
Feasibility studies
Cost benefit analysis
Input analysis
Environmental analysis – IEE, EIA
2.1 Concept of Project Appraisal

 Appraisal is the evaluation of the ability of the project to succeed.

 This is an evaluation report of proposed project that is prepared
before signing the agreement or memorandum of understanding
(MOU).
 The objective of the appraisal is to study and compare the possible
feasible project and select the best one.
 Appraisal is done systematically to provide an overall assessment
of the project’s likelihood for success.
 Project Appraisal Answers two important Questions
1.Will the project as designed meet its objectives?
2.How the project is better, compared to other alternatives? (if
more than one project has been found feasible)

The primary function of appraisal is to evaluate a project's ability

to achieve its objective.
For private project, profitability is the objective.
For Public project, socio-economic development is objective.
Project appraisal
• Project appraisal involves detailed pre-investment analysis of market,
technical feasibility, financial soundness, economic desirability and
measuring its investment worthiness.
• Ensure that Scarce resources are to put to most effective use
• Utilize limited resources at its optimum, economic use of resources –
resources are to be utilized in best possible ways
• To determine proposed project is the best to achieve desired
objective
• Combined effort of engineers financial analyst, economists is required
 Socio-
Technical Environmental Economic
Appraisal Appraisal Appraisal
Project appraisal

Market Financial Management

Appraisal Appraisal Appraisal
2.2 Project proposal – initial steps
Needs/demand
• Need analysis
• Other economic activities (business, industry)

Knowledge
• Technical
• Financial analysis
• Social analysis

Methods ( at this stage detailing not required)

• Reconnaissance
• Conceptualization
• RRA/PRA
• Financial Analysis
Overview: What is a project proposal?
A project proposal is a document that outlines
everything stakeholders need to know to initiate a
project. It’s a necessary first step towards getting a
project off the ground. A project proposal is usually
selected during the project intake process.
A well-written project proposal informs and persuades,
and combines project management skills with a few
other essential skills: research, data analysis, and some
copywriting.
A well-written project proposal informs and persuades, and combines project management skills with a few other
essential skills: research, data analysis, and some copywriting.

It follows conventional proposal formats that include the following elements:

Executive summary. Short and to the point, the executive summary is essentially the project’s elevator pitch. It states the
problem clearly, addresses how your proposed project intends to solve the problem, and discusses what a successful
project looks like.
Background or history. This section outlines both successful and unsuccessful previous projects, including how the latter
could have been handled better, with the goal of showing how the proposed project will be more successful based on the
lessons of the past.
Requirements. This section briefly summarizes what’s needed throughout the project life cycle in terms of resources,
tools, project schedule, etc.
Solution. The solution section explains how you intend to approach the project and bring it to completion. It covers the
project management steps, techniques, and skills needed to get things done more efficiently, as well as how to manage
problems.
Authorization. This section states explicitly who the project’s decision-makers are and the stakeholders authorized by the
client to make approval/sign-off decisions.
Appendix. Any information not included in the actual proposal should be in the appendix, such as materials and resources
that team members and stakeholders can use to learn more about the project.
If you’re not sure where to start, know that some of the best project management software applications offer project
proposal templates you can use for free from their tools library.
Project proposal (technical and financial)

Project appraisal, among others, mainly consists of;

• Financial aspects
• Technical aspects
• Kind of technology in use – old, new, etc.
• Life of the technology – lasts till the end of project??
• Technology proven or needs adaptation under local circumstances
• Availability – locally available, to be imported, licensing, HR availability,
technology backstopping, updated/upgraded. Maintenance services etc.
• Conclude whether technically possible or not
Project proposal (technical and financial)
contd.

Project appraisal, among others, mainly consists of;

• Technical aspects
• Financial aspects
• Quantum of investment (costs)
• Cost of financing the investment (equity, loan, subsidy etc.)
• Quantum of revenue and projections (revenue stream)
• Cash flow analysis ( cost of debt services, anticipated return on equity, profits
etc.)
2.3 Procedures for developing project proposal
project Proposal report
Objective/purpose – to communicate formally the project promotor’s
decision of venturing a new project to financial institutions for their
perusal and government departments for approvals.
Components of Project Proposal
• General information
• Background and experiences of the promoters
• Detail and working results of already owned projects of the
promoters
project proposal report contd…
• Details of the proposed project
• Plant capacity
• Production process
• Technical know-how and tie up if any
• Management team for the project
• Details of land, building and plant machinery
• Details of infrastructure facility available ( power, water, transport etc)
• Raw material requirement and availability
• EIA and mitigation measures
project proposal report contd..
• Labor requirement
• Schedule of implementation
• Project cost
• Financing – funding – equity, loan, grant
• Working capital requirement/arrangement
• Profitability and cash-flow analysis/tax liability etc.
• Debt and debt services
• Government approvals, licensing, local body approvals and statutory
requirements
• Collateral and other financial security
The word ‘proposal’ literally means “an act of putting forward
or stating something for consideration”. This relates to business
proposals, marriage proposals, legal proposals, and research
proposals in addition to project proposals.

In the non-profit world, a proposal is a document with which

an NGO puts forward a specific project to a donor for funding
consideration. Thus, a proposal is a tool for NGOs to gain
funding, and for donors to decide who to fund.

In other words, a project proposal explains the plan and

purpose for the set of activities an NGO wishes to implement,
and requests funding from a donor.
While the basic parts of a proposal are fairly standardized,
every proposal is unique. Each NGO, project, and donor is
different, so good project proposals take all of these factors
into account.

Additionally, each donor may have their own application

requirements to include.

While a good proposal is often essential to securing a grant, it

is only one piece of the larger application process. Even before
putting pen to paper, creating a good project to write about
requires a lot of background research and planning.
include:
•Cover Page
•Table of Contents
•List of Abbreviations
•Executive Summary
•Project Rationale
•Background
•Project Goals and Objectives
•Project Strategies and Activities
•Project Results
•Monitoring and Evaluation Plan
•Sustainability Plan
•Work plan or Timeline
•Budget
•Logical Framework
•Annexes
•Appendix
2.4 Techniques of project formulation

• Techniques of project formulation

Feasibility studies
Cost benefit analysis
Input analysis
Environmental analysis – IEE, EIA
Feasibility studies
Components of project appraisal and feasibility studies
• Technical feasibility
• Economic viability
• Commercial viability or market appraisal
• Financial feasibility
• Environment impact study
• Social acceptability
• Institutional or management
Technical feasibility
• Concept of project or preliminary design
• Technology to be adopted – commonly used, complex, innovative
• Kind of technology in use – old, new, etc.
• Life of the technology – lasts till the end of project??
• Technology proven or needs adaptation under local circumstances
• Availability – locally available, to be imported, licensing, HR availability,
technology backstopping, updated/upgraded. Maintenance services etc.
• Conclude whether technically possible or not
Technical Appraisal implies
to mean the adequacy of the
proposed plant and equipment
to produce the product within
the prescribed norms. As
regards know-how, it denotes
the availability or otherwise of
a fund of knowledge to run the
proposed plants and
machinery.
 Technical Appraisal
While assessing the technical feasibility of the project, the
following inputs covered in the project should also be taken into
consideration:
(i) Availability of land and site.
(ii) Availability of other inputs like water, power, transport, communication
facilities.
(iii) Availability of servicing facilities like machine shops, electric repair shop,
etc.
(iv) Coping-with anti-pollution law.
(v) Availability of work force as per required skill and arrangements proposed
for training-in-plant and outside.
(vi) Availability of required raw material as per quantity and quality.
Economic viability or appraisal
• Proposed investment will yield satisfactory return to economy
• Better use of raw materials or input
• Reduce use of scarce resources
• Benefit to community and nation
• Uplift the living standards of beneficiaries
 ECONOMIC APPRAISAL

Payback period (Both Simple and Discounted); Project is feasible if

PBP is < standard PBP
Net Present Value – Project is feasible if NPV > 0 (+ve),
IRR/ERR – Project can be accepted if IRR/ERR > MARR (Minimum
Attractive rate of Return)
BCR – If BCR > 1 Accept the Project
calculated considering all direct as well as indirect cost and benefit
of the Project
Commercial viability or market appraisal
• Possibility of successful marketing
• Will the product be accepted
• For a new product – systematic market survey is essential to estimate
demand, plant capacity should be less than the demand to avoid
pitfalls,
• If the product is not new – systematic market survey to estimate
competitive edge in terms of quality, price, and consumer’s
acceptability should be analyzed.
 Market Appraisal
Before the production actually starts, the entrepreneur needs
to anticipate the possible market for the product. He/she has
to anticipate who will be the possible customers for his
product and where and when his product will be sold. There is
a trite saying in this regard: “The manufacturer of an iron nails
must know who will buy his iron nails.”

Product has no value unless it is sold.

Thus knowing the anticipated market for the product to be

produced becomes an important element in every business
plan
Financial feasibility or appraisal
• Quantum of investment
• Cost of financing the investment (equity, loan subsidy etc.)
• Quantum of revenue and projections
• Cash flow analysis ( cost of debt services, anticipated return on
equity, profits etc.)
Financial Appraisal
Finance is one of the most important pre-requisites to establish an
enterprise. It is finance only that facilitates an entrepreneur to bring
together the labour of one, machine of another and raw material of yet
another to combine them to produce goods.

In order to adjudge the financial viability of the project, the

following aspects need to be carefully analysed:
Assessment of the financial requirements both – fixed capital and
working capital need to be properly made.

Fixed capital normally called ‘fixed assets’ are those tangible and
material facilities which purchased once are used again and again. Land
and buildings, plants and machinery, and equipment’s are the familiar
examples of fixed assets/fixed capital.
Financial appraisal
• Fund source – sound capital structure
• Working capital requirement
• Cash flow to cover debt service liability
• Realistic cost estimate
• profit level
• Break even point
• Pay back period
• IRR, B/C Ratio
Environmental impact analysis
• Environmental impacts of the project
• Positive/negative and degree of impacts – identify them
• Project should meet regulatory environmental concerns
• Environmental impact mitigation measures – cost and social
acceptability
ENVIRONMENTAL APPRAISAL OF PROJECTS (EAP)
is defined as: Identification Prediction Interpretation,
Communication of information about the impact of
a project on man's health and well being. Study of
changes in socio-economic and bio-physical traits of
the environment , which may result from the project.

Basically it includes:

IEE: Initial Environmental Examination for small Projects

EIA: Environmental Impact Assessment for Big Projects
Environment Aspects
Environment impacts includes
• Ecological – Fisheries, tree plantation, habitats, endangered species,
forest, wetlands
• Physio chemical – flood, drainage , erosion, water logging, soil fertility,
• Human interest – settlements, agricultural lands, irrigation, land
value, water use, land use
Social impacts analysis
• Social acceptance
• Impacts on society – positive/negative and degree of impacts
• Social impacts could be – employment, gender concern, living
standards, social harmony etc.
Institutional or management appraisal
• Institutional ability to handle the project
• Experience of top management
• Expertise and ability of supervisory staff
• Clarity of job – roles and responsibility (job description)
• Balance between supervisory staff and workers
Organizational and Managerial Appraisal:
A project report contains an organisation structure drawn along with the suggested number of employees and their levels and
grades. These organisations recommended in the reports are, however, impersonal and primarily deal with the functional
relationship within the project team, taking care of the work-load involved in the respective areas.

The organizational and managerial appraisal is carried out recognising that:

(i) The complexities in project management require a well-knit project organisation structure, which again depend upon the
volume and nature of the project as well as the culture and motive of the project owner. For example, in case of a owner-managed
small project, the structure is simple and the appraisal is limited to the assurance that the owner is assisted whole-time/part-time
by other functionaries.

In case of a medium sized project the owner still holds the rein for the project management but prefers to carry out the
implementation with the help of a project manager. The situation is different for complex and large projects.
(ii) Experience suggests that the project organisation should have an overall in-charge as project manager with the quality of
strong leadership and effective communicating ability besides the required theoretical and technical skill.
(iii) The organisation structure should be interlaced so that the project work is carried out in a unified way.
(iv) The managerial personnel heading the different functions should be duly skilled in their respective functions to carry out the
project implementation and operation. The appraisal is to ensure that the key managerial personnel have been fixed before the
start of the work; it is also desirable to appraise the backgrounds of such personnel.
As a matter of practice, the financial institutions in the process of project appraisal also look out for the background of the key
managerial personnel in the relevant project management.
(v) Organisation takes care of the technical training required for the production process.
Outcome of feasibility studies
• Whether the project is technically viable or not
• Whether the project is environment friendly and viable in terms of
social acceptance or not.
• Whether the project is economically and or financially feasible
considering commercial aspects or not.
• Overall ranking of the project for its implementation priority if many
such projects are under consideration.
•
Cost benefit analysis
• A cost benefit analysis is a tool to evaluate cost versus benefits of a
project. All project expenses and tangible benefits are calculated in
order to derive at internal rate of return (IRR), Net Present Value
(NPV) and pay back period.
• The objective of CBA is to determine if the project is justifiable or
feasible in terms of benefits outweighing costs and to compare which
project more benefits than its cost.
• CBA need to consider - Project goals, alternatives, stakeholders,
outcome of cost and benefits, currency, discount rate, NPV, sensitivity
analysis,
Input analysis
• Consideration/identification of project inputs
• Input characteristics
• Its assesses the input requirements during the construction and
operation of the project •
• It defines the inputs required for each activity •
• Inputs include materials, equipment, machines, software, human
resources etc.
• Cost estimations and etc.
Input ………Processs……….output
Environmental analysis – IEE, EIA

• IEE: Initial Environmental Examination for small Projects

• EIA: Environmental Impact Assessment for Big Projects
• Environmental Impact Assessment (EIA) is a process of evaluating the likely
environmental impacts of a proposed project or development, taking into
account inter-related socio-economic, cultural and human-health impacts, both
beneficial and adverse. The significance of EIA is: 1) EIA is more than technical
reports, it is a means to a larger intention – the protection and improvement of
the environmental quality of life. 2) EIA is a procedure to identify and evaluate
the effects of activities (mainly human) on the environment - natural and social.
• Screening is the first stage of the EIA process which results in a key EIA decision,
namely to either conduct the assessment (based on the likely significant impacts)
or not conduct it (in the anticipated absence of such impacts). Scoping. Establish
the boundaries of the EIA, set the basis of the analyses that will be conducted at
each stage, describe the project alternatives and consult the affected public
Tamakoshi
Installed Capacity = 456 MW
Estimated Cost = 40 billion = 40,00,00,00,000
Per MW cost = 40 billion /456 = 8.77 crore
Average cost per MW > 20 crore
But actual cost = 80 billion/456 = 17 crore/mw
If Village (RVT Location ) RL = 1200m

and Source RL = 1150 m is it Ok?

Pumping is necessary – it requires electricity
If there is no electricity in that village – Technically
Unfeasible. If yes Electricity- Technically Feasible
Ktm valley Gas Project
Estimated Cost = 90 crore
Project period = 25 years Gas…for KTm residents.
i.e Project period = 25 years
Payback period = 13 years.
Is it feasible? But Unfeasible!
Our company policy – to invest in a project with
PBPeriod < 10 years is Standard PB period….
IRR and MARR ?
IRR is the interest rate earned by investing in a
project

and MARR is the interest rate to be paid to BANK

Rural Water supply project costs 50 lakh
How do you calculate benefit of the project in
monetary value?
Or
Can you calculate BCR?

Rukum- 1 gagri pani lina --- 4 hours (1-1/2hr to go+1/2

hr to Fetch + 2 hr for Coming back)
Labour = 1 day = 400 Rs….= 8 hr….
1 gagri = 4 hr = ½ day = 200 OPPORTUNITY COST
say 100 hh x 5 gagri per day … monetize it….
Group Work:
Prepare Technical Appraisal (Roll 49-58), Economic
appraisal (Ro-59-68), Financial Appraisal (69-78…),
Environment Appraisal (79-88.) Market appraisal
and Management Appraisal (roll 89-96 ) and
Present in class tomorrow..
Melamchi Water Supply Project
Chapter 3: Project planning and scheduling
Concept of project planning and its importance
Project Planning Process
Work Breakdown Structures (WBS)
Project scheduling with bar chart, CPM and PERT
Project scheduling with limited resources (resource levelling and smoothing)
Introduction to planning software `
 CHAPTER 3:
Planning and Scheduling
What is planning?
• Thinking ahead of an operation to be performed. Planning is a
function of deciding what has to be done, how, by whom, by when
and with what.
• Doing the job in the mind before it is done in the field.
Introduction to Project Planning
According to Stephen P. Robbins:
Planning is deciding in advance about what to do, how to
do, when to do and who is to do it etc. It provides the end
to be achieved.
According to Richard Steers:
Planning is the process by which managers define goals and take
necessary steps to ensure that these goals are achieved. Planning is
a mental exercise that requires imagination, foresight, and sound
judgment. It is thinking before doing, looking ahead, anticipating
future and deciding the course of action to be taken.
 Construction Project Planning

• Planning is the mental process

deciding about the future line of
actions.
• It sets a clear road map that should
be followed to reach a destination.
"If you fail to plan, you are bound to
fail”
Success in terms of Time, Quality and
Cost of project

18-Aug-21 5
Reasons for planning?
• To eliminate or reduce uncertainty
• To improve efficiency of the operations
• To obtain better understanding of the objectives
• To provide basis for monitoring and controlling the work – to monitor
performance in terms of output, time and money
• To keep the plan under constant review and make action when necessary to
correct the situation

Planning is one of the major managerial functions and Project manager is

responsible for planning. Mangers who do not plan cannot control because they
have no yardstick to judge the progress. Hence, many managers do realize
paramount importance of planning. A written plan communicates the project
strategy for achieving project objectives.
Objectives of planning:
• Analysis – how, in what order, with what resources, with appropriate
WBS
• Anticipation – foresee potential difficulties, anticipate risk and plan to
overcome them accordingly.
• Scheduling resources
• Coordination and control – provide basis for co-ordinating the work
among concerned; provide a basis for predicting and controlling time
and cost.
• Production of data - to provide a framework for decision making in
the event of change.
What to plan?

• Construction Planning mainly consists planning of 5Ms.

• Man – personnel
• Machine – equipment/tools
• Materials - construction materials
• Money- Finance
• Minutes - time
Information required for preparing a Plan
A complete understanding of project is a must for better planning.
• Resources – availability, organization and utilization of 4 Ms.
• Activities – the type of work and resources, the location and restraints.
• Logic – the interdependence and relationship
• Duration – the quantity, resources and output of resources
• External constraints – delivery dates, restriction on access to parts of the works
• Responsibilities
• Future problems – potential difficulties
• Project time scale
• Work method
• Costs and value
• Levels of detail
Working to the Plan – Plan the work and work
the plan

• Planning is not worth the paper on which it is written, if it is not

implemented and monitored. Planning only will not ensure that
projects are completed on time. Arrangements for working to the
plan are also important. This needs commitment and most
importantly periodical measurement of progress of forecasting how
long it will take to complete the remaining work. Comparing the
forecast with the previous plan allows the need for corrective action
to be taken.
Consequences of poor planning

• Wild enthusiasm
• Disillusionment
• Search for scapegoat
• Punishment of innocent
• Promotion of non-participants
• Chaos
 Steps to Create a Construction Project Plan:
Project Plan Step 1 – Defining the Scope (?) Defining the scope involves gaining
agreement on the metric that the sponsor (the boss, executive or customer) will use
to measure the end result of the project. Install 2MW of hydropower Plant/
Construction 5 story Building.
Project Plan Step 2 – Breaking Down the Scope into Major Deliverables: If
Building Construction is a Project Specific Deliverables are Buying of Land, Map
approval from Municipality, Contractor Selection, Construction etc are deliverables.
Project Plan Step 3 – Breaking Down the Major Deliverables: Eg. For Buying of
Land – advertisement, visit the seller, visit the Land, Negotiation, Check all the
Documents, Transfer the ownership etc…
Project Plan Step 4 – Estimating: Each of the tasks/Activities will have an estimate
of the amount of work and the duration. This is finalize the Budget and Schedule
(Duration)
Project Plan Step 5 – Final Approval By the Sponsor: The last step in developing
the project plan is to secure the sponsor’s final approval on the project scope, major
Work Breakdown Structure
What Is Work Breakdown Structure in Project Management?
• Work breakdown structure (WBS) in project management is a method for
completing a complex, multi-step project. It's a way to divide and conquer
large projects to get things done faster and more efficiently.
• The goal of a WBS is to make a large project more manageable. Breaking it
down into smaller chunks means work can be done simultaneously by
different team members, leading to better team productivity and easier
project management.
• A Work Breakdown Structure (WBS) is a deliverable-oriented hierarchical
decomposition of the work to be executed by the project team to
accomplish the project objectives and create the required deliverables.
A WBS is the cornerstone of effective project planning, execution,
controlling, monitoring, and reporting.
Use of WBS
• it facilitates the quick development of a schedule by allocating effort
estimates to specific sections of the WBS. it can be used to identify
potential scope risks if it has a branch that is not well defined. it
provides a visual of entire scope. it can be used to identify
communication points.
• Used for planning, monitoring, controlling
• Used for estimate and cash flow
• Calculation of resourses
• Etc.
Work breakdown structure
WBS
Factory construction project
• Survey
• Design
• Concept design
• Preliminary design
• Final design
• Architectural
• Design
• Drawings
• Plan
• Elevation
• Section
• details
• Prospective view
• model
• Structural
• Plumbing
• Electrical

• Foundation
• Fabrication
• Installation
• Handover
Project scheduling with bar chart, CPM and PERT
 How to Estimate time for Activity?
Suppose Activity is EW in Excavation – 20 m^3 from Drawing
Civil Engineering Norms ?

For 1 m^3 Hard Soil Excavation – approx. 0.8 man-days of labor

So, to excavate 20 m3 we need 20x0.8 man-days = 16 man days of labor

This means if we have 1 labour it takes 16 days or if we have 16 labours –

1day

If we have 4 labour = 4 day This is how we fix duration

Project Title: Construction of A Residential Building
From Site Clearance upto DPC – Damp Proof
Course
Foundation work
1. Site Clearance
2. Layout
3. Excavation
4. Laying Foundation stone - silanyas
5. Soling (Brick)
6. PCC at the foundation of Column
7. Column Construction – Hatti paile and Column
8. Masonry work (Brick in Ktm, Stone in many other areas)
9. DPC – Tie Beam
10.Backfilling
Gantt chart/Bar chart Introduction to Planning Tools
The oldest formal planning tool is the bar chart.
It is developed in 1917 by Henry L. Gantt, an
American mechanical engineer, hence also
called Gantt chart in his respect.
Gantt chart provides a graphical illustration of a
schedule that helps to plan, coordinate, and
track specific tasks in a project.
A Gantt chart is constructed with a horizontal
axis representing the total time span of the
project, broken down into increments (for
example, days, weeks, or months) and a vertical
axis representing the tasks that make up the
project
Horizontal bars of varying lengths represent the sequences, timing, and time
span for each task/activities. Length of the Bar represents the time required to
complete the Activity. Total Project duration is also seen.

The bar spans may overlap, as, for example, you may conduct Research before
completion of Planning and similarly you may start Design before completion
of the Research.

As the project progresses, secondary bars, arrowheads, or darkened bars may

be added to indicate completed tasks, or the portions of tasks that have been
completed. A vertical line is used to represent the report date.
Steps in Preparing Bar Chart
The following are the important steps in developing a bar chart.
1. Identify different activities within the work: Prepare Work Breakdown
Structure i.e. breakdown the project into its various activities or jobs or
operations, each representing manageable units for planning and control.
2. Estimate time required to complete each activity: Based on resource
availability, historical data, experience and expert opinions, estimate the time
required to complete each activity.
3. Develop logical sequence between activities: Activities should be performed
or completed in a definite sequence. So, decide the sequence in which the
activities are to be performed.
4. Develop a bar chart. Represent the above information in the Bar chart,
indicating the relative positions of each activity.
The advantages of Bar chart are:
1. It is simple to understand: Even a person with little
education can understand the concept quite easily. This
may be the reason that bar chart is popular in every
sector.
2. It is easy to prepare, consume less resources and
economical. No sophisticated tools and Special
knowledge is not required to prepare the bar chart hence
it is easy and economical.
3. It can be used to show progress. Simple "fill in the bar"
method is used to show how much of the project was
complete. It can also be shown by the planned bar
alongside the progress bar like. Figure 2.2: Progress shown in bar chart
4. It can be used for resource planning such as manpower
planning, budgeting etc.
5. It gives clear pictorial model of the project.
Disadvantages /Limitation of Bar chart
The Bar chart suffers from some disadvantages which limits its usefulness:
1. There may be physical limit to the size of the bar chart, which may limit the size of the project that can be
planned with this technique or only major activities are shown. Hence, it is not useful for large and complex
projects.
2. There are some activities of a project which are taken up concurrently, while there are others which can be
taken up only after completion of some other activities. Similarly some activities can be started few days after
the other activity starts. The activities whose start and end depend on other activities are shown serially. In a
project, there may be large number of activities which can start with certain degree of concurrency. By
merely depicting them parallel, interrelationship between them cannot be clearly depicted.
3. Each activity receives equal importance due to the lack of special indication in the chart. Thus in bar chart,
long duration activity may appear most important ones, which may not be true. In building construction,
plastering work, may take long time but concreting may be completed in a single day and concreting is more
important activity.
4. It is difficult to show critical path, critical activities and floats available.
5. Data is hard to manipulate i.e. it cannot easily cope with frequent changes or updating. The bar chart is a
static representation of the planned activities and does not respond to the dynamic happening on the
construction site of the complex project.
A milestone chart is a tool used to Milestone Charts
visualize milestones, which are the
significant planned events that are When to use a milestone chart
scheduled to happen during a specific Anytime your team collaborates
time in a project timeline. It highlights the
planned dates and the completion
on a large project with multiple
of milestones. tasks and deadlines, you can use
a milestone chart.
A milestone chart is a visual
representation of important events, You may also find it useful to
known as milestones, planned in a share the milestone chart with
project’s timeline. Milestone charts. It your managers or customers to
shows one milestone per vertical line, update them on your progress
with a description on the left-hand and likelihood of meeting your
side of the milestone, and a overall deadline.
horizontal timescale for the whole
Examples of milestone chart

Gantt Chart with 4 Mile Stones

The linked bar chart shows the links A variation of the bar chart schedule is
between an activity and its preceding the linked bar chart. A linked bar
activities which have to be complete before chart uses arrow and lines to tie the
this activity can start. activities and subsequent items, specifying
the successors and predecessors of every
activity.
 Network Technique of Scheduling CPM and PERT
There are two popular network based scheduling techniques.
a) Critical Path Method – CPM developed in the year 1957 by Morgan R.
Walker of DU Pont and James E. Kelly of Remington Rand for preparing
shutdown schedule of a chemical plant.

b) ProgramEvaluation and Review Technique – PERT, developed by US

Navy in 1956-1958 for scheduling Polaris Missile Project.

Though the two methods are conceptually

similar [Apply Network Technique]
except for certain minor differences, they
were developed independently in USA.
For understanding as to how a network for a project is drawn, we should
get ourselves familiarized with the following terminologies.
1. Activity (Task): An activity is any identifiable job which requires time,
manpower, material, and other resources to complete. It means the
performance of the specific task of project. Arrow in a network diagram
represents activity. The following are the examples of activity for a building
construction project
Activity is shown by arrow pointing from i1 2j
a. Left to right b. right to left • Layout
c. Top to bottom and d. bottom to top • Excavation of foundation
• Construction of wall
Length of arrow is ….. To activity duration • Concreting
a. Directly proportional • Construction of roofing
b. Inversely proportional • Wiring and electrification
c. Both a and b
d. None
A project is a collection of various activities and those activities are
interrelated among themselves.
Concurrent (Parallel) Activities: Those activities which can be
performed simultaneously and independently to each other are
known as concurrent activities. In figure below activities A and B
are parallel.

Parallel activities are also called

a. Similar
b. Concurrent
c. Both
d. None
Serial Activities: Those activities which are to be performed one after the other, in
succession are known as serial activities. Serial activities cannot be performed
independently. In the figure below earthwork in excavation and construction of wall
are serial activities.
A - Earthwork in Excavation B - Construction of Wall
1 2 3
In the above figure, activity A i.e. Earthwork in excavation is preceding
activity (Predecessor) of activity B i.e. Construction of wall. Or, we can
say that Construction of wall (B) is succeeding activity (Successor) of
Earthwork in excavation (A). This means activity A must be completed to
start activity B.
For a given activity, the activity that occurs immediately before it is its
predecessor where as for a given activity, the activity that follows immediately
after it, is its successor.
An Activity which starts after completion of
an Activity is known as …..

a. Predecessor
b. Successor
c. Both
d. None
 Event (Node):
The beginning or end of the activity is known as event. It represents specific point
in time and does not consume time, manpower, material and other resources.

Event Event Event

• The circle at the beginning of the activity (event) is known as tail
event/burst event where as circle at the end of the activity (event) is known
as head event/merge event.
• Event is symbolically represented by numbers or alphabets written inside
the circle.
• In a network, some events work as head event for an activity and tail event
of another activity. Such events are known as Dual Role Event.(2) is Dual
Role in above figure.
Generally, the name of the activity (Or symbol of the activity is) is
indicated above the arrow while the duration of the activity is
indicated below the arrow.
Construction of Wall
Earthwork in Excavation
1 2 3

12 days
7 days

Event 1 is the tail event of Activity – Earthwork in excavation

Event 2 is the head event of activity – Earthwork in excavation as
well as tail event of activity – construction of wall. Hence event 2 is
dual role event.
Event 3 is the head event of activity – construction of wall
 1 2 3
1

Tail/ Burst event Head/ Merge event Dual Role event

 Dummy activity
A dummy activity is an imaginary (hypothetical) activity included in a network.
Since it is not a real activity, it does not consume time, manpower, material and
other resources. It is included in a network to maintain the relationship between
activities appropriately. It is represented by dotted arrow.
Dummy is …. A. Imaginary Activity b. Requires no reosurces c Requires No
time D. ALL
Uses of dummies: Dummies serve two purposes in a network:
a) Grammatical purpose and b) Logical purpose
1. Grammatical purpose: It is used to prevent two arrows having common beginning and end
nodes for two or more activities. For example, consider the arrows of activities A and B;
both starts from node 1 and end at node 2. Due to this an inconvenience results when the
network is used for computation, i.e., uniqueness in the identification is lost. This
inconvenience frequently leads to mistake.
1. Logical purpose: Dummies are also used to give logical clear representation
in a network having an activity common to two sets of operations running
parallel to each other.
A-5d
1 2

B- 3d

Logical Dummy
A. – Wait delivery of new machine
Grammatical Dummy B. – Install new machine
C. – Remove existing machine
D. – Dispose of existing machine
 A. – Wait delivery of new machine
B. – Install new machine
C. – Remove existing machine
D. – Dispose of existing machine

Logical Dummy

Set 1 activity A and B are to be performed serially while Set 2 activities

C and D are to be performed serially. Both the sets are performed
simultaneously. However, for practical considerations, we find that
activity D of set 2 cannot be performed unless activity A of set 1 is
completed. Hence a dummy is used joining node 5 and 7 indicating that
activity D cannot be started unless activity A is completed.
 2
C-1
4
TYPICAL CPM A-2
NETWORK 1 D-5 F-3
6 Activities A- F
5 events (1) to (5) B-4 3
5
E-6

Activity Duration Predecessor Successor Remarks

A 2 - C
B 4 - D, E
C 1 A F
D 5 B F
E 6 B -
F 3 C and D -
 2
C-1
4
CPM NETWORK A-2
analysis 1 D-5 F-3

B-4 3
5
E-6
There are three Paths from First Event 1 to Last Event 5
Path Description Duration Remarks
1 1-2-4-5 (A-C-F) 2+1+3 = 6
2 1-3-4-5 (B-D-F) 4+5+3 =12 Longest
3 1-3-5 (B-E) 4+6= 10
• Longest path in the network is called Critical Path – Path 2 (1-3-4-5 (B-D-F)
• Activities Lying on critical Path are Critical Activities B, D and F
• Time required to travel longest path is Project Duration - 12
FIND CRITICAL PATH, CRITICAL ACTIVITIES
AND PROJECT DURATION
There are three paths:
Paths DESCRIPTION DURATION REMARKS
1 10-30-40-50 3+1+3 = 7 mo Maximum
2 10-30-50 3+3 = 6 mo
3 10 -20-50 4+3 = 7 mo Maximum

There are two longest Paths 10-30-40-50 and 10 -20-50

so two critical Paths
critical Activities are A, D, F , B and C So only E is non cr
Project Duration are 7 months
 Rules of Drawing Network diagram
The following network rules are noteworthy
1. All activities shall be represented by way of straight arrows
pointing towards the right. This means flow of network shall be
from the left to the right.
2. There must be only single initial node as well as ending node in a
network. Initial node has only outgoing arrow where as ending
node has incoming arrows.
3. An event cannot occur twice, i.e. there cannot be any network path
looping back to previously occurred event. No event depends, for
its occurrence upon the occurrence of a succeeding event. Thus
network shown in figure below is incorrect.
5. There shall not be any criss crossing of arrows??
6. There should be only one arrow for an activity, i.e.
number of arrows should be equal to number of
activities.
7. There shall not be unnecessary dummy activities in the
network. Dummy activity shall be introduced only when
it is absolutely necessary and without which the network
diagram cannot be completed.
1. In Bar chart Length of the Bar is 2. Which of the following chart
……… to activity duration shows the relationship between
Activities clearly
a. Directly proportional
b. Inversely proportional a. Gantt Chart
c. Both a and b b. Milestone Chart
d. None c. Linked Bar chart
d. All of the above

3. Bar chart is also know as 4. In Bar chart Activities are

a. Gantt Chart represented by
b. Milestone Chart a. Horizontal Bar
c. Linked Bar chart b. Vertical Bar
d. All of the above c. Both a and b
d. None of the above
Draw CPM Network. Find Critical Path, Critical Activities and Project Duration
Activity Duration Predecessor Successor Remarks

A 2 - C
B 4 - D, E
C 1 A F
D 5 B F
E 6 B -
F 3 C and D -

Solution

A- 2 c- 1
A- 2 c- 1

D- 4
B- 4 D- 4
B- 4
E- 6
E- 6
 A- 2 c- 1
A- 2 c- 1

D- 4
B- 4 D- 4
B- 4
E- 6
E- 6

WRONG RIGHT

c- 1 F- 3 F- 3
c- 2

D- 4 F- 3 D- 4
RIGHT
WRONG
E- 6 E- 6

F- 3 F- 3

WRONG RIGHT

Funkerson’s Rule of Numbering

Events
Path 1: 1-2-4-5 Ok (Increasing)
Path 2: 1-3-4-5 OK (Increasing)
E= 6 Path 3: 1-3-5 Ok (Increasing)
Objective Type Questions

1. Which of the Following is 2. Bar Chart is also known as

not Network Based technique
of scheduling a. Gantt chart
a. Bar chart b. Milestone chart
b. CPM c. Linked Barchart
c. PERT d. ALL
d. ALL
5. Which of the Following is 6. Activity Requires
Event ? a. Time
a. Earthwork in Excavation b.Resources
b.Plastering works c. Both a and b
c. Excavation Completed d. None
d.All
7. Event Requires
a. Time
b.Resources
c. Both a and b
d. None
8. An event which is head event of an Activity and Tail event of
another activity is known as..

A. double role event

b. dual role event
c. multiple role event
d. all

9. Event is a moment and it does not requires time and resources

A. Time B. Resources C. Both A and B D. None

10. Which of the following is Event?

A. EW excavation Finished B. Excavation Started C. Both A and B
D. None
Draw a network with the following details. Number the events using
Fulkerson’s rule Find critical path and Project Duration

SN Activity Duration Predecessor Successor

1 A 2 - B, C
2 B 3 A D
3 C 1 A E, F
4 D 5 B G
5 E 4 C G
6 F 6 C -
7 G 2 D, E -
 SN Activi Durati Predec Success
ty on essor or

1 A 2 - B, C
2 B 3 A D
3 C 1 A E, F
4 D 5 B G
5 E 4 C G
6 F 6 C -
Path 1 is 1 – 2 – 3-5-6 =2+3+5+2= 12 7 G 2 D, E -
Path 2 – 1-2-4-5-6 = 2+1+4+2 = 9
Path 3, 1-2-4-6 = 2+1+6 =9
Critical Path is 1 – 2 – 3- 5 – 6 longest with 12 duration
Critical Activities are A, B , D and G
Project Duration = 12
Draw CPM Network Find critical path Critical Activities and Project Duration

SN Act Dur Pred Suc

1 A 1 - C
2 B 2 - D,E,F
3 C 3 A G
4 D 4 B G Critical Path
5 E 5 B - B, F and H
6 F 6 B H
7 G 7 C,D - Project
Duration =
8 H 8 F -
2+6+8=16
 C-3
2 4
A -1

D-4 G-7
1
E-5
B-2 3 6

F-6 H-8
5

Paths Description Duration Remarks

1 1-2-4-6 1+3+7 =11
2 1-3-4-6 2+4+7 =13
3 1-3-5 2+5 =7
4 1-3-5-6 2+6+8 =16 Longest –
Critical Path
B,F and H are Critical Activities with 16 Project Duration
Finding Critical Path in Large network:
The method of finding out the number of paths available in a given network
connecting the initial and final events, finding the time duration of all the
available paths and identifying the critical paths is suitable for small
networks.
If the network is relatively larger in size, there will be larger number of
paths available connecting the initial and final events. In such cases, it
would be cumbersome to find out all the possible paths.
Hence in the case of large networks, a more systematic procedure is
followed to identify the critical path. The method uses two series of
computations viz., Forward pass computation and Backward pass
computation.
 Forward pass computation: Backward pass computation:
• In the forward pass calculation, all • In the backward pass calculation, all
activities in the network are activities in the network are assumed
assumed to start as early as to start as late as possible.
possible.
• The calculation begins from the right
• The calculation begins from the
to the left side of the network.
left to the right side of the
network.
• When two or more activity merges at
• When two or more activities
a node, the smallest value is taken as
merge into an event, the largest
a latest occurrence time of that event.
value is taken as an earliest
occurrence time of that event.
• Backward pass calculation gives the
• Forward pass calculation gives
LST and LFT of each activity.
the EST and EFT of each activity.
 6 12 Forward Pass Calculation
15 19-
- Left to right addition
4=15
4 4 process – take maximum
value

0 0 Backward Pass Calculation

Right to left- deduction
19 19 Take minimum value
9 9

Critical Path is 1 - 2 – 4- 5-6; Cr activities are A, C, E, and G; Project Duration = 19

Event No. 1 2 3 4 5 6
Early 0 0+4 = 4 4+2 = 6 4+5= 6+3= 9 15 + 4=19
Event time 9 9+6=15 9+1 = 10
Late 4-4 =0 12-2=10 15- 3 =12 19-1=18 19- 4 =15 19
Event
Time 9-5=4 15-6=9
 A
E-i L-i i j E-j L-j

Tail Event Head Event

Where E-i is the Early Event Time of Tail Event – Also

Early Start Time [EST] of The Activity A [E-i]
L-i is the Late Event Time of Tail Event
E-j is the Early Event Time of Head Event and

L-j is the Late Event Time of Head Event – Also

Late Finish Time of the Activity A – L-j
 6 12
15 15
4 4
0 0

19 19
9 9

E-i L-i E-j L-j

6 12 15 15
A
D-3 i j
3 5

Activity E-i (EST) L-i E-j L-j (LFT)

D 6 12 9 15
 6 12 E-i L-i E-j L-j
15 15
4 4 A
i j
0 0
4 4 6 12

9 9
2 B-2 3
19 19

Activity Dur E-i (EST) EFT = EST + D LST = LFT -D L-j (LFT) Total Float Remarks
A 4 0 4 0 4 0 Critical
B 2 4 6 10 12 12-6=6 Non-Cr
C 5 4 9 4 9 0 Critical
D 3 6 9 12 15 15-9=6 Non critical
E 6 9 15 9 15 0 Critical
F 1 9 10 18 19 19-10=9 Non critical
G 4 15 19 15 19 0 Critical
 A
E-i E-j i j L-i L-j

EST (Earliest Start Time): It is the earliest possible time an activity or operation can
be started. It is equal to earliest occurrence time of tail event of that activity. E-i

EFT (Earliest Finish Time): It is the earliest possible time for completion of an
activity or operation without delaying the project completion time. It can be computed
by adding by activity duration by EST. EFT = EST + duration

LFT (Latest Finish Time): It is the latest time the activity or operation must be
completed so that scheduled completion date of the work can be achieved. It is equal to
latest occurrence time of head event. = L-j

LST (Latest Start Time): It is the latest possible time; an activity can be started
without delaying the project. LST = LFT-Duration
 The free time available for the activity is called ‘Float’ or ‘Slack’. An activity has
four types of floats.
1. Total Float 2. Free Float and 3. Independent Float 4. Interfering Float
1. Total Float (TF): Late Start Time – Early Start Time or = Late Finish Time –
Early Finish Time
Total Float represents the maximum time by which the completion of the activity can
be delayed without affecting the project completion time. If an activity is delayed by
a time equal to its total float, that activity and all other subsequent activities in that
path become critical.
1. Free Float (FF): It is the delay that can be permitted in an activity so that
succeeding activities in the path are not affected. If the succeeding activities are to
remain un-affected by the delay in a particular activity the earliest start Time of
the head event of that activity shall not be exceeded.
2. Independent Float (IF): It is the spare time available for the activity, if preceding
activity is started as late as possible and succeeding activities are finished as early
as possible.
 4 5 6 12
E-i L-i A E-j L-j
B-2 j
2 3 Predecessor
i
Successor

Activity TF= (L-j)-(E-i) – D FF = (E-j) – (E-i) -D Int F = TF-FF IndF- (E-j) - (L-i) – D Remark
s
B =12-4-2=6 =6-4-2=0 =6-0=6
Total Float (TF) = [ (L-j) – (E-i) – D ] or LFT – EFT or LST – EST
Free Float (FF) = (Ej) – (Ei) – D < TF = EST of Succ – EST of Act – Dur
FF = EST of Successor – EFT of the Activity (EFT = EST + dur)
Independent Float (IF) = (Ej) – (Li) – D = EST of Suc – LFT of Act – dur = < FF or FF –
tail event slack
Interfering float = TF – FF = (Lj- Ei –d)- (Ej-Ei-d) =(Lj) - (Ej) = LFT of Act – EST of
Suucessor
 6 12 E-i L-i E-j L-j
15 15
4 4 A
i j
0 0
4 4 6 12

9 9
2 B-2 3
19 19

Activity TF =(L-j) –(E-i) -d FF = (E-j) –(E-i) -d intF = TF-FF IndF =(E-j) –(L-i) - d Remarks
A 4-0-4 = 0 4-0-4=0 0-0=0 4-0-4=0 Critical
B 12-4-2=6 6-4-2=0 6-0=6 6-4-2=0
C 9-4-5 =0 9-4-5=0 0-0=0 9-4-9=0 Critical
D 15-6-3 =6 15-6-3=6 6-6=0 15-12-3=0
E 15-9-6=0 15-9-6=0 0-0=0 15-9-6=0 Critical
F 19-9-1=9 19-9-1=9 9-9=0 19-9-1=9
G 19-15-4 19-15-4=0 0-0=0 19-15-4=0 Critical
 E-i L-i E-j L-j
A-3 E-i = 4 A
1 2
L-i = 5 i j
E-i=4 L-i=5 E-j= 8 L-j= 12 4 5 8 12
E-j = 8
L-j = 12 3
2 B-2
Activity TF =(L-j) –(E-i) -d FF = (E-j) –(E-i) -d intF = TF-FF IndF =(E-j) –(L-i) - d Remarks
A 12-4-3 =5 8-4-3 =1 5-1=4 8-5-3=0
B 12-4-2=6 8-4-2=2 6-2=4 8-5-2=1

TF= L-j - E-i – d = LST – EST or LFT - EFT

FF= E-j - E-i -d
Inter Float = TF – FF = L-j - E-j
Ind Float = E-j - L-i - D
 6 12 E-i E-j L-i L-j
15 15
4 4 A
i j
0 0
4 4 6 12

9 9
2 B-2 3
19 19

Activity Dur EST EFT LST LFT TF FF IntF IndF Remarks

A 4
B 2
C 5
D 3
E 6
F 1
G 4
 6 12
15 15

0 0
4 4

19 19

9 9

EFT= LST=
SN Activity Duration EST EST+D LFT-D LFT TF FF IndF IntF Remarks
1 A 4 0 4 0 4 0 0 0 0 Critical
2 B 2 4 6 10 12 6 0 0 6
3 C 5 4 9 4 9 0 0 0 0 Critical
4 D 3 6 9 12 15 15- 6 0 0
6-
3=6
5 E 6 9 15 9 15 0 0 0 0 Critical
Draw a network with the following details. Number the events using
Fulkerson’s rule. (DUMMY …)

SN Activity Predecessor Successor

1 A - B, C
2 B A D
3 C A E, F
4 D B F
5 E C -
6 F C, D -
SN Activity Predecessor Successor
1 A - B, C
2 B C D ONE ACTIVITY ONE ARROW?
3 C A E, F
4 D B F What to DO?
5 E C -
6 F C, D -

D
5
3
B

A dummy
1 2
6
E
4
C
SN Activity Predecessor Successor

1 A - B, C
2 B A D
3 C A E, F
4 D B F
5 E C -
6 F C, D -
SN Activity Predecessor Successor
1 A - B, C
2 B A D
3 C A E, F
4 D B F
5 E C -
6 F C, D -
 Draw a CPM network and Find EST, EFT, LST, LFT, TF, FF, IntF and IndF. Show
critical path also.

Activity A B C D E F G H

Predecessor - - A B B C,D E E, F

Duration 2 6 3 5 7 1 4 5
 b. Define Total Float , Free Float and Independent flaot. Draw a CPM
network and Find EST, EFT, LST, LFT, TF, FF, IntF and IndF. Show critical path
also.
Activity A B C D E F G H
Predecessor - - A B B C,D E E, F
Duration 2 6 3 5 7 1 4 5

11 12
2 9 13 13 Forward Pass Calculation
C-3 F-1
0 0 A-2 2 H-5
4 6
1 D-5 18 18
dummy
B-6 7
3 5
E-7 G-4
6 6 13 13
Backward Pass Calculation
 Activity A B C D E F G H

Predecessor - - A B B C,D E E, F

Duration 2 6 3 5 7 1 4 5
EST (Ei) 0 0 2 6 6 11 13 13
EFT = EST + dur 2 6 5 11 13 12 17 18

LST = LFT - dur 7 0 9 7 6 12 14 13

LFT = L-j 9 6 12 12 13 13 18 18

2 9
11 12 13 13
C-3 F-1
0 0 A-2 2 H-5
4 6
1 D-5 18 18
dummy
B-6 7
3 5
E-7 G-4
6 6 13 13 Backward Pass Calculation
Forward Pass Calculation
 Activity A B C D E F G H

TF 9-0-2=7 6-0-6=0 12-2-3=7 12-6-5=1 13-6-7=0 13-11-1=1 18-13-4=1 18-13-5=0

Duration 2 6 3 5 7 1 4 5

F = (E-j) – (E-i) – du 2-0-2=0 0 11-2-3=6 11-6-5=0 0 13-11-1=1 18-13-4=1 0

nter Float TF - FF 7-0=7 0 7-6=1 1-0=1 0 1-1=0 1-1=0 0

nd F = Ej –Li - dur 0 0 11-9-3= -1 0 0 13-12-1=0 18-13-4=1 0

2 9
11 12 13 13
C-3 F-1
0 0 A-2 2 H-5
4 6
1 D-5 18 18
dummy
B-6 7
3 5
E-7 G-4
6 6 13 13 Backward Pass Calculation
Forward Pass Calculation
Draw a CPM network and Find EST, EFT, LST, LFT, TF, FF, IntF and IndF. Show
critical path also.

Activity A B C D E F G H
Predecessor - - A A B B C, D E D, E, F
Duration 2 6 3 5 7 1 4 5

c G

d
H
E

F
 b. Define Total Float , Free Float and Independent flaot. Draw a CPM
network and Find EST, EFT, LST, LFT, TF, FF, IntF and IndF. Show critical path
also.
Activity A B C D E F G H
Predecessor - - A A B B C, D E D, E, F
Duration 2 6 3 5 7 1 4 5

C-3
A-2
2 5 G-4
D-5
Dummy Dummy -1 from 4 to 5
1 7
4 Dummy 2, 4 to 6
E-7 Dummy
B-6
3 6 H-5
F-1
Activity A B C D E F G H I J K L M
Predecessor - - A A,B B C D D E D,F H,I H,I G,
J, K
Duration 2 6 3 5 7 1 4 5 6 2 3 4 1

C
A
Dummy
D

Dummy
B
E
Activity A B C D E F G H I J K L M
Predecessor - - A A,B B C D D E D,F H,I H,I G, J,
K
Duration 2 6 3 5 7 1 4 5 6 2 3 4 1

F-1
C-3 4 8
2 J-2
A-2 Dum-3
dum1 D-5
1 G-4
5 7 10 M-1
B-6 dum2 K-3
H-5 11
3
E-7 6 9 L-4
I-6
 b. Define Total Float , Free Float and Independent flaot. Draw a CPM
network and Find EST, EFT, LST, LFT, TF, FF, IntF and IndF. Show critical path
also.

Activity A B C D E F G H I J K L M
Predecessor - - A A,B B C D D E D,F H,I H,I
Duration 2 6 3 5 7 1 4 5 6 2 3 4 1
 C E
A
dummy dummy

B
D F
 . Draw a CPM network and Find EST, EFT, LST, LFT, TF, FF, IntF and IndF. Show critical
path also.

Activity A B C D E F G H I J K L M
Successor D E,G,H,I,J F G,H L,M I,J K L,M L,M M - - -
Duration– 6 3 4 2 3 1 5 2 4 3 2 1 5
Days
 Chapter 4: Project
Implementation and controlling
,
4. Project Implementation and controlling
• Introduction to monitoring, evaluation and controlling
• Project Control
• Project Control Cycle
• Elements of project control (Time, Cost, Quality)
• Project schedule control
• Project cost control: methods and procedure (EVA)
• Project Quality Control
• Introduction to PMIS
4.1 Introduction to monitoring, evaluation and
controlling
M&C, M&E
Monitoring and control processes continually track, review, adjust and
report on the project's performance. It's important to find out how
a project's performing and whether it's on time. This ensures
the project remains on track, on budget and on time
Monitoring is the collection and analysis of information about
a project or programme, undertaken while the project/programme is
ongoing. Evaluation is the periodic, retrospective assessment of an
organisation, project or programme that might be conducted internally
or by external independent evaluators.
Monitoring and controlling
• Monitoring and controlling is the management function of comparing
the actual achievements with the planned ones at every stage and
taking necessary action, if required, to ensure the attainment of the
planned goal.
Project Monitoring
• Regular observation and recording of project activities. Gathering
information on project how it is moving on.
• To check how project activities are progressing
• Giving feed back for making decisions for improving project
performances.
Project evaluation
• Project evaluation is a systematic and objective assessment of an
ongoing or completed project. The aim is to determine the relevance
and level of achievement of project objectives, development
effectiveness, efficiency, impact and sustainability. Evaluation is
periodic: mid term, initial evaluation, yearly evaluation, ex-post
evaluation
Types
• Internal
• External
4.2 Project control

Project control should not replace project planning. If project is not

moving as per plan than control is required to bring the project into
track. Control is taking actions/intervention to remedify the defects or
errors.
Effective project control consists of a process that:
• Identifies potential hazards well in advance of their occurrence
• Evaluate impact of hazards where possible and work out mitigation
measures
• Constant surveillance to create no surprise condition
Feedback in control system

System

Control Sensor
Device

Feedback Control for a system

Input Process Output

Feedback
Types of control system
• Closed control system – like thermostat – automatic and does not depend on
outer environment
• Open control system – like country’s economy – external environment would be
considered for decision

• Closed control loops are automated, which is insulated from disturbance of

environment. For example, thermostat in the heating system or computer control
process etc.

• Open control loops is on with random disturbances. For example, human control
element etc.

Systems should be designed to make it as closed as possible.

Control system
.
Collect data

historical Planned target Current progress

Evaluation

Decision making
Project Control
4.3 Project control cycle
7 step control cycle
1. Project
Implementation

2. Establish
datum

7. Take corrective
actions if deviation is 3. Collect data during
not acceptable implementation

6. Decide if 4. Compare with datum

deviation is
acceptable

5. Note the deviations

Project control cycle

.
•.
Controlling in a project
Project control cycle
Controlling is three-step process consisting of:
• Measuring degree of progress towards an objective
• Evaluating what remains to be done – possible ways of improvement
• Correcting - Taking corrective actions on unfavorable trend to achieve
objectives
 3 step control cycle
Measuring
Determining through formal and
informal reports the degree to
which progress towards objectives
id being made

Evaluating
Correcting Determining cause of and
Taking control action to correct
possible deviations from
an unfavorable trend or to take
planned performance
advantage of an unusually
favorable trend.

Project control steps

Effective control system shall include:
• Thorough planning of the work
• Good estimating of time, labor and costs
• Clear communication of the scope of required task
• Budget and authorization of expenditure
• Timely accounting of physical progress and cost
• Periodic re-estimation of time and cost
• Comparison of actual progress and expenditures to schedules and
budgets
4.4 Project control elements
• Time - Control of progress, time schedule as agreed
• Quality - Control of quality of works, performance - specification
• Cost - Control of cost, accounting system – budget, estimate

• Project success??? – if all the three elements/indicators are within an

acceptable level of deviation
Elements of project control
4.5 Project schedule control
Control of progress will help:
• To give an idea of amount of payments to be made
• To give information about project on schedule or behind schedule
• To take corrective steps well in time to bring the project on schedule
• To work out profit margin of client or contractor
.
.
Progress in terms of time
Methods of recording progress:
• Job/daily diary – every thing of importance will be noted down in the diary.
• Register of instruction or instruction book – channel of communication
between the engineer in-charge and the contractor.
• Progress report – report to the owner about the progress of work on a
regular basis including updated schedule.
• Construction report/measurement sheet – record of time, quality and
quantity of work ensuring satisfactory progress as per specification.
• Abstract of quantity – measurement of executed works. Measurement
Book is the basis of payment in government system.
Schedule control
With the data obtained, comparison is made between;
• Schedule and actual start dates
• Schedule and actual time of an activity
• Schedule and actual milestones
4.6 Cost control
• Cost control measures should start right from the inception of the project.
• It is easier to make changes in the project at initial stage. As the project
advance, chances of reducing cost through various cost control measure
reduces.
• Usually project manager do not feel the seriousness of the situation and
do not properly monitor the project activities frequently. When they find
the project is in problem it becomes too late for them to be able to correct
and bring the project in the original track resulting in cost and time
overrun.
• Cost control can be achieved by appropriate decision-making process and
financial control system.
Decision-making in cost control
• Delay in decision-making incurs more cost.
• Prompt decision is prerequisite for better-cost control
• Decision should be well received in time and disseminated correctly
to lower levels to make it cost effective.
• Decision is influenced by feedback, which flows from bottom to top.
Appropriate feed back system should be in place for cost control.
Elements/steps of cost control
Observation – regular observation of:
• Martial consumed
• Manpower consumed
• Equipment employed
• Other direct cost
Comparison – comparison of observed data with design standard/estimate by calculating variance.
Reason for variance – for greater variances, reason for variance should be well explained by checking
• Purchase price
• Quality
• Wastage and use
• Work conditions etc
• Corrective action – having known acceptable limit in comparison and reason for variance, corrective actions
should be worked out and implemented, which may include re-estimate of the project.
Cost Control Techniques
Short term planning and control
Project cost control models – S curve and EVA
Accounting method of control
• Overall - profit and loss account
• Profit - loss on valuation date
• Unit costing

1 - Planning the Project Budget. You would need to ideally make a budget at the beginning
of the planning session with regard to the project at hand.
2 - Keeping a Track of Costs.
3 - Effective Time Management.
4 - Project Change Control.
5 - Use of Earned Value.
Earned Value Analysis (EVA)
• EVA compares the value of work done with the value of work that should
have been done.
• Many of the project control systems assume a direct relationship between
lapsed time, work performed and incurred costs. EVA system analyses each
of these components independently comparing actual data to base line
plan set at the beginning of the project.
• EVA is often presented in the form of progress, productivity, or S- curve
diagrams.
• Actual and estimated costs are made available to determine the progress
factors at any stage of the project. Progress and cost factors are used to
monitor variance and trends for individual activities.
Earn value analysis
•.
Terms used in EVA
• Budgeted cost of work scheduled (BCWS) - is the value of work that should have been done at a
given point of time.
• Budgeted cost of work performed (BCWP) – is the value of the work done at a point of time. This
takes the work that has been done and the budget for each task, indicating what potion of the
budget ought to have used to achieve it.
• Actual cost of work performed (ACWP) – is the actual cost of the work done.
• Schedule variance (SV) – is the value of the work done minus the value to the work that should
have done (BCWP-BCWS). A negative number implies that work is behind schedule.
• Cost Variance (CV) – is the budgeted cost of the work done to date minus the actual cost of the
work done to date (BCWP-ACWP). A negative number implies a current budget overrun.
• Schedule performance index (SPI) – is (BCWP/BCWS) x 100. Values under 100 indicate that the
project is behind schedule.
• Cost performance index (CPI) – is (BCWP/ACWP) x 100. Values under 100 indicate that the project
is over budget.
EVA
BCWS, BCWP, ACWP
• 10000 m3 of concrete was planned to be completed in six month
@10,000/m3 = 1,000,000,00 - -------- BCWS
• 8000 m3 of concrete could be casted in six month @ 10,000/m3 that
equals to 800,000,00---------------------BCWP
• 8000m3 of concrete could be casted in six month at actual cost
@15,000/m3 that equals 1,200,000,00 ----ACWP
EVA
.
EVA
EVA
Comparison of project as per CPI and SPI
• Project A
• CPI = 70%
• SPI = 95%
• Project B
• CPI = 96%
• SPI = 93%
• Project C
• CPI= 102%
• SPI = 101%
4.7 Quality Control
Quality definitions
• Degree of goodness – oxford dictionary
• Conformance to requirements.
• Zero defects
• Doing things right first time
• Quality is the totality of characteristics of an entity that bear on its
ability to satisfy stated and implied needs.
Facts and Misconceptions
• Quality is not grade.
• Quality costs more, but lack of quality costs even more.
• Quality is means of achieving project success. It is not the goal in
itself.
• Process quality is more than product quality.
• Quality standards does not demand the best quality, they establish
the minimum requirements to be achieved.
Quality Management
• Quality Control
• Quality Assurance
• Total Quality Management
Quality Control
QC concerns the operational means to fulfill the quality requirements.
• Detection of non-conformity
• Verification of conformity
Stages of QC
• Input - Incoming goods, services and information
• In-process
• Output - End product
Quality Assurance
• QA aims at providing confidence in fulfilling the requirements both within
the organization and externally to customers and authorities.
• A systematic way of ensuring those organized activities happen in a way
that they are planned.
• QA is concerned with anticipating problems and with creating the attitudes
and controls that prevent problems arising. It is a logical extension of good
management practice.
• QA firstly, it aims to impart confidence to the client assuring that his needs
will be consistently met (external quality assurance). Secondly, it aims to
achieve quality through systematic and planned actions avoiding ‘fire-
fighting or crisis management’ (internal quality assurance).
Quality management and TQM
• QM includes QA and QC as well as other concepts of quality
planning, quality policy and quality improvement.
• TQM develops these concepts as a long-term global management
strategy and the participation of all members of the organization for
the benefits of the organization itself, its members, its customers and
society as a whole.
4.8 Project Management Information System
• Project
• Management – marketing, accounting, finance, production and R and D are
coordinated by management hierarchy. Top, middle and supervisory
management level. Top managers need information highly summarized
supported primarily by decision support system for strategic planning. Middle
managers need summarized information with detail for tactical planning and
control. Supervisory mangers should be supported by transactional processing
information system for operational control.
• Information - data that have been shaped or formed by humans into a
meaningful and useful form
• System - is a group of elements either human or non-human that is organized and
arranged in such a way that the elements can act as a whole towards achieving
some common goal, objective or end. System exists on continuous basis.
Communication - PMIS
• One of the major contributors of project success is good communication system
and set up of information system for effective communication. PMIS is employed
for effective communication. Software can be developed and communication
logistic can be added for better information system.
• An idea, no matter how great, is useless until it is transmitted and understood by
others.
• Communication is transference (imparting) and understanding of meaning.
• Barrier of communication
• Perception
• Filtration
• Environmental disturbance
• language
Knowledge - PMIS
Difference among Knowledge, information and data
• Data – raw facts that can be shaped and formed to create information
• Information - data that have been shaped or formed by humans into a
meaningful and useful form
• Knowledge – the stock of conceptual tools and categories used by human
to create, collect, store and share information
• Information system – it can be defined as a set of interrelated components
working together to collect, retrieve, process, store and disseminate
information for the purpose of facilitating planning , control, co-ordination,
and decision making in business and other organizations
•
Three basic activities of IS
• Input – collection of raw data resources from within a business or
from its external environment
• Processing – the conversion of raw input into more appropriate and
useful form
• Output – the transfer of processed information to the people or
business activities that will use it.
• Feedback – output that is returned to appropriate members of the
organization to help them refine or correct the input phase.
•
Activities of IS

Environment

Organization

Input Process Output

Feedback

Activities of information system; input, processing and output

Information system
• Information system essentially transform into a form usable for coordinating the flow of
work in a firm, helping employees or managers make decisions and solving other kinds of
problems.
• Decision-making and Control – alterations and other guidelines that employees are to
follow etc.
• Information and record - for taking decisions and have decision choices.
Formal and informal information systems
• Formal – information systems that rely on mutually accepted and relatively fixed
definition of data and procedures for collecting, storing, processing and disseminating
information. E.g. library catalogue
•
• Informal – does not have features of formal information. Not established system like
what is information, how it will be stored, and what will be processed. Office gossip
network, friends circle.
Formal Project PMIS
• Daily diary – all activities of the day is noted down
• Progress report – monthly, quarterly , yearly
• Financial Progress report – trimesterly
• Project completion report
• Record photographs
• Progress photographs
• Monitoring reports
• Regular meetings – site, management, tripartite
Choice of information channel
• Face to face talk, meetings – lesser chance of miscommunication
• Telephone/supporting aids
• Electronic mail/internet
• Memos and letters
• Flyers, bulletin and general reports
• TV and Radio etc.
Feasibility assessment of IS
• Technical – I/O devices, capability, software items, operating systems,
special language. What impact on the organization and people employing
the new system
• Economical – cost saving that IS can accrue and added benefits, reduction
of manpower, computerization cost and meaningful and more timely
information. Better inventory system and control. JIT inventory pattern,
other intangible benefits.
•
• Operational – to produce forecasted benefit, problems related to
motivational and psychological aspects should be removed through
trainings. Need to assess management, non-management and general
operational consideration
 Chapter 5: Project Risk
analysis and management
,
Project Risk analysis and management
• Project Risk analysis and management
• Introduction to project risk
• Types of project risk
• Analysis of major source of risk
• Effective management of project risk
• Risk management planning’
• Risk identification
• Quantitative and qualitative risk analysis
• Risk response planning
• Risk monitoring and controlling
5.1 Introduction to project risk
Introduction to Project Risk
Risk management is the process, which enables the analysis and
management of the risks associated with a project.
RM increases the likelihood of successful completion of a project to
cost, time and performance.
With ample data risk can be assessed statistically. No two projects are
the same and often things go wrong for reasons unique to a particular
project. Hence the increased need of proper risk management.
Risk Management includes:
• Risk analysis
• Risk management
Introduction to Project Risk
• Risk exists as a consequence of uncertainty.
• Uncertainties and risk could be of various types like: un-established
management and financial structure, not proven technology,
problems related to industrial relations and scarcity of resources.
These uncertainties exposes the project to risk that may cause failure
to keep budget within limit, complete project in time and to required
performance.
Procedures for decision making are modified if risk analysis is adopted.
Cost and time are produced in the form of ranges and associated
probabilities rather than single value figures.
Project risk management Process
Suitability, which projects?
• The more the risks or more innovative the project the greater will be
benefits. On small project the budget will probably justify only a low level
of application, perhaps omitting the quantitative analysis.
• Innovative, new technology projects
• Large investment projects
• Fast track projects
• Projects which interrupts crucial revenue streams
• Unusual agreements - legal, insurance and contractual
• Projects with sensitive issue - environment, relocation
• Projects with stringent requirements - regulatory or safety
• Projects with political/economical/financial parameters
Benefits of risk analysis and management
• An increased understanding of the project leading to more realistic plan
• Understanding of risk and allocation of risk to the party best able to handle
them
• Selection of suitable type of contract
• Justification for decision
• Assessment of contingencies
• Information of historical risks will assist in better modeling of future
projects
• Facilitation of greater, but more rational risk takings thus increasing the
benefits that can be gained from risk taking.
• Assistance in the distinction between good luck and good management and
bad luck and bad management
5.2 Types of project risk

Broadly types of risk can be categorized as;

• Internal – Lack of ownership and priorities, institutional and organizational issues,
Project management (poor leadership, lack of experience, poor communications,
lack of resources, personal issues, lack of skills, lack of commitment, lack of
logistics, inappropriate schedule etc) contract types, procurement process, use of
unproven or nonstandard technology, inappropriate selection of consultants and
contractors .
• Internal risks exist within your organization and are easier for you and your team to mitigate
and manage.
• External – weather conditions, political changes, approvals, changes in law (legal),
market conditions, Funding (reduction in available capital, cash flow issues,
inflation), stakeholders or end users issues, environmental requirements,
• External risks happen outside of your organization and are typically beyond your control as a
team or project manager.
Common risk areas
• Cost risk: is anything that affects your ability to stick to the project
budget, whether it’s the result of scope creep or overly optimistic
project estimates.
• Schedule risk: refers to any factors that jeopardize project deadlines.
These may include pop-up feature requests, a team member who’s
out sick for an extended time, or unexpected delays in supply
delivery.
• Performance risk: impacts project goals and outcomes. This could
result from a lack of stakeholder support, an overworked team, or
misaligned project expectations.
,
5.3 Analysis of major source of risk
• Project management risk
• Market risks – commercial risk, price rise, competitors, real states
• Technical risks – unproven technology, inappropriate technology, design
• People risk, – obstructions and hurdles related to people
• Process risk – faulty documentations,
• Financial risks – cost overrun, funding
• Political and social risk – unstable government, policies, communities objections
• Construction risk – selection of contractors, scarcity of materials etc.
• Legal risk - change in law, permits and approvals
• Natural calamities – flood, earthquake, land slides
• Environmental risks – environmental thresholds
• Etc.
5.4 Effective management of project risk

• Risk management planning

• Risk identification
• Quantitative and qualitative risk analysis
• Risk response planning
• Risk monitoring and controlling
Effective management of project risk
Risk management planning

A document that details risk management process of an organization or

project. A document prepared by the project manager to foresee risks,
its identification, evaluating them in terms of probability of occurrence
and impacts (risk assessment matrix) and finally define responses to
risks.
Procedures for decision making are modified if risk analysis is adopted.
Cost and time are produced in the form of ranges and associated
probabilities rather than single value figures.
Risk identification

Process of determining risk is called risk identification, which can be

done by
• Documentation reviews
• Information gathering techniques
• Brainstorming
• Interviewing
• SWOT analysis
• Root cause analysis
• checklist analysis - final stage to look if any risk are overlooked
Quantitative and qualitative risk analysis

Risk Analysis is study of risk

• Qualitative analysis - focus on identification and subjective
assessment of risks.
• Quantitative analysis - focus on an objective assessment of the risk.
a) Qualitative analysis
Qualitative analysis
• Main risk sources or factors are identified by the use of checklist,
interviews or brain storming sessions.
• Assessment could be the description if each risk and its impact or a
subjective labeling as high/low in terms of both impact and
probability.
• The aim of Qualitative analysis is to identify key risks (between five
and ten), which are then analyzed and managed in more detail
Qualitative analysis contd.
• Qualitative - the first and most important step is identification. This
can be done by interviewing, organizing brainstorming meetings and
using personal experience. Checklist can be used.

• The second step is categorizing the risks into high/low probability of

occurrence (likelihood) and major/minor impact (consequences) on
the project.

• Initial and urgent responses are also identified Secondary risk are also
to be identified that may arise in mitigating on category of risk.
 Risk analysis matrix
Probalility of occurance Impacts Prioritization

S. No Identified risks High Medium Low High Medium Low ranks

1People's obstruction Y y 3

2Material scarcity y y 5

3Earthquake y y 6

4Funding arrangment y y 1

5cashflow y y 4

6labor scarcity y y 2

8
.
b) Quantitative analysis
Quantitative analysis
• Often involves sophisticated techniques requiring level of efforts ranging
from modest to extensively thorough, usually requiring computer use.
• Quantitative analysis includes measurement of uncertainty in cost and time
estimates and probabilistic combination of individual uncertainties

An initial qualitative analysis is essential, which creates an understanding and

helps to work towards developing a specific plan to deal with specific risk
issue.
Quantitative analysis
Quantitative - quantification is done against three project success factors cost, time and
performance.
• Sensitivity analysis - simplest form of RA. Considers one risk variables like delay in
design. SA is done for all risk having potentially high impact on cost or time scale of the
project. It highlights on how the effect of a single change in one risk variable can produce
a marked difference in the project outcome.
• Probabilistic analysis - specifies a probability distribution for each risk and then
considers the effect of risks in combination. Sampling techniques - Monte Carlo
Simulation.
• Influence diagram - relatively new technique and by the use of computer a very complex
risk models can be used to analyze cost, time and economic parameters of projects.
• Decision trees - graphical method that bring together the information needed to make
project decisions and show the present possible courses of action and future possible
outcome. The out come must be given in probability value indicating its likelihood of
occurrence.
.
Risk response planning

• Avoid or remove
• Reduce
• Transfer
• Accept
Risk management – risk response
Management of risk can be done by adopting some of the following
ways
• Identify preventive measures to avoid a risk or to reduce its effect
• Establish contingency plans to deal with risks if they should occur.
• Initiating further investigations to reduce uncertainty through better
information
• Consider risk transfer to risk insurers
• Consider risk allocation in contracts
• Set contingencies in cost estimates, float in programs and tolerances
in performance specifications
Risk monitoring and controlling

• Re-assess the Risks regularly

• Weekly
• Monthly
• yearly
• Monitoring mechanism
• Inspection, checking, testing of risk status

• Controlling - intervention
.
Chapter 6: Introduction to
project financing
,
Introduction to project financing
• Project finance
• Capital structure planning
• Capital budgeting decision
Project Finance
• Project finance is the long-term financing of infrastructure and industrial
projects based upon the projected cash flows of the project rather than the
balance sheets of its sponsors. Usually, a project financing structure
involves a number of equity investors, known as 'sponsors', and a
'syndicate' of banks or other lending institutions that provide loans to the
operation. They are most commonly non-recourse loans, which
are secured by the project assets and paid entirely from project cash flow,
rather than from the general assets or creditworthiness of the project
sponsors, a decision in part supported by financial modeling. The financing
is typically secured by all of the project assets, including the revenue-
producing contracts. Project lenders are given a lien on all of these assets
and are able to assume control of a project if the project company has
difficulties complying with the loan terms.
Project finance
• Generally, a special purpose entity is created for each project, thereby
shielding other assets owned by a project sponsor from the
detrimental effects of a project failure. As a special purpose entity,
the project company has no assets other than the project. Capital
contribution commitments by the owners of the project company are
sometimes necessary to ensure that the project is financially sound or
to assure the lenders of the sponsors' commitment. Project finance is
often more complicated than alternative financing methods.
Traditionally, project financing has been most commonly used in the
extractive (mining), transportation,[2] telecommunications, and power
industries, as well as for sports and entertainment venues.
Project finance
• Risk identification and allocation is a key component of project finance. A
project may be subject to a number of technical, environmental, economic
and political risks, particularly in developing countries and emerging
markets. Financial institutions and project sponsors may conclude that the
risks inherent in project development and operation are unacceptable
(unfinanceable). "Several long-term contracts such as construction, supply,
off-take and concession agreements, along with a variety of joint-
ownership structures are used to align incentives and deter opportunistic
behavior by any party involved in the project. The patterns of
implementation are sometimes referred to as "project delivery methods."
The financing of these projects must be distributed among multiple parties,
so as to distribute the risk associated with the project while simultaneously
ensuring profits for each party involved. In designing such risk-allocation
mechanisms, it is more difficult to address the risks of developing
countries' infrastructure markets as their markets involve higher risks.
Project finance
Project Finance
,
Capital structure planning

• Capital structure refers to an arrangement of the different

components of business funds, i.e. shareholder's funds and borrowed
funds in proper proportion. A business organization utilizes the funds
for meeting the everyday expenses and also for budgeting high-end
future projects
.
.
.
.
.
Capital budgeting decision
• Capital budgeting is the process of making investment decisions in
long term assets. It is the process of deciding whether or not to invest
in a particular project as all the investment possibilities may not be
rewarding. ... That is why we have to value a project in terms of cost
and benefit
Capital budgeting decision criteria
1) discounted payback period, 2) net present value, 3) modified rate of
return, 4) profitability index, and 5) internal rate of return. We employ
a unifying concept, cumulative present value (CPV), to highlight the
commonalities among these criteria.
 CHAPTER 6
Project Finance Capital Planning & Budgeting

6.1 Concept of project finance

No universally accepted definition of the term “project financing” --different people uses it in different
senses. Project financing refers to a financing in which lenders to a project look primarily to the cash
flow(revenues) and assets of that project as the source of payment of their loans. In other words, project
finance is the long-term financing of infrastructure and industrial projects based upon the projected cash
flows of the project rather than the balance sheets of the project sponsors. Usually, a project financing
structure involves a number of equity investors, known as sponsors, as well as syndicate of banks that
provide loans to the operation. The loans are most commonly non-recourse loans which are secured by
the project assets and paid entirely from project cash flow rather than from the general assets or
creditworthiness of the project sponsors a decision in part supported by financial modelling.

Project financing differs from conventional financing in the following aspects

 In conventional financing, cash flow from different assets and business are co-mingled. A
creditor makes an assessment of repayment of his loan by looking all the cash flows and
resources of the borrower. In project financing, cash flow from the project related assets alone
are considered for assessing the repaying capacity. Even if one has already established many
projects, for financing a new project promoted by him, the cash flows from the proposed new
project are alone taken into account for carrying out the viability study.
 In conventional financing end use of the borrowed funds is not strictly monitored by the lenders.
In project financing, the creditors ensure proper utilization of funds and creation of assets as
envisaged in the project proposal. Funds are also released in stages as and when assets are
credited.
 In conventional financing, the creditors are not interested in monitoring the performance of the
enterprise and they are interested only in their money getting repaid in one way or the other.

Er. Santosh Kr.Shrestha Er. Ishwar Adhikari

 Project financiers are keen to watch the performance of the enterprise and suggest / take
remedial measures as and when required to ensure that project repays the debt out its cash
generations.

6.2 Capital Budgeting

Capital budgeting decision is the investment decisions of a firm. It may be defined as the firms’ decision
to invest its current funds most efficiently in long term activities in anticipation of an expected flow of
future benefit over a series of years. The long-term activities are those activities which affects firm’s
operation beyond the one-year period.

6.2.1 Nature of investment decisions

Investment are of two types – investment in fixed assets and investment in current assets. Investments
in the fixed assets, which have long terms implications for the firms in terms of expenditure and benefits
is evaluated as capital budgeting decision. The capital budgeting excludes investment required for
current assets.

Thus, generally, investment decision (or capital budgeting decisions) of a firm includes following types
of investment:

 Addition, disposition (placing in order), modification and replacement of assets in a long-

term basis.
 Introducing a new product
 expanding the business

All the above types of investment decisions involve comparison between different alternatives or
investment proposals. Each of these investment proposals should be evaluated on the basis of a criterion
that is compatible with the objective of maximizing the market value of the firm. Any such criterion will
involve the use of the concept of the minimum rate of return required by the investor. The market value
of the firm will increase if the investment project yields a rate higher than the minimum expected by the
investor.

Er. Santosh Kr.Shrestha Er. Ishwar Adhikari

Following are some of the important features of capital budgeting

 The exchange of current funds for future benefit (i.e. funds are invested only for future benefits)
 Funds are invested in long terms activities
 The future benefits will occur to the firms over a series of years (i.e. funds are invested only if
the future benefits occur over a series of years)

6.2.2 Importance of capital budgeting

Since capital budgeting decision are among the most crucial and critical business decisions, special care
should be taken in their treatment. The followings are the reasons for placing greater emphasis on the
capital budgeting decisions,

1. They have long term implications for the firm, and influence its risks complexion.
First, the effect of capital budgeting decisions will long term implications for the firm. Firms
decision to invest in long term assets has a decisive influence on the rate and direction of its growth.
A wrong decision can provide disasters for the long-term survival of the firm. For example,
unwanted expansion of assets will result in unnecessary heavy operating costs.

2. They involve commitment of large amount of funds.

Secondly, the capital budgeting decisions involve large amount of funds for long period. Such
commitment may also change the risk complexions of the firm. If investment increase and the
earning are fluctuating the firm will become riskier.

3. They are irreversible decisions

Thirdly, in most of the cases capital budgeting decisions are irreversible. The reason for
irreversibility of the capital budgeting decision is that it is very difficult to find a market for such
capital goods. The only alternative available is to scrap the asset, and incur heavy loss.

4. They are among the most difficult decision to make

Er. Santosh Kr.Shrestha Er. Ishwar Adhikari

 Finally, the capital budgeting decisions are also important because they are more difficult to make.
These decisions require an assessment of future events which are benefits and costs, mainly due to
economic, political social and technological forces.

6.2.3 Capital budgeting process

Capital budgeting process involves the following steps:

 Project generation
 Project evaluation
 Project selection
 Project execution

These four steps are necessary, but more may be added to make the process more effective.

As the capital budgeting decision involve commitment of large amount of funds for longer period, often
irreversible, such decisions need to be made by the highest level of management. This means substantial
part of the process should be confined to the top management, and when some of its parts are delegated,
a system of effective control by the top management must be evolved.

Project generation

Any project needs a written material- proposal – to initiate dialogue on funding. So, project generation
is development of proposal for investment decision. The investment proposal of any type can originate
at any level – from top management level to the level of worker. The proposal may focus in adding new
equipment for increasing the rate of production, or it may focus to reduce the cost of production. There
may be several kinds of proposal. Such proposal may originate systematically or haphazardly. In view
of the fact that enough investment proposals should be generated to employ the firms fund fully and
efficiently, a systematic procedure for generating proposals most be involved. The healthy firm is one
in which there is a continuous flow of profitable investment proposals.

Project evaluation

Er. Santosh Kr.Shrestha Er. Ishwar Adhikari

While evaluating a project following point should be considered

a) Estimate on cash flow, which is difficult, as future is uncertain

b) Selection criteria to judge the project viability
c) Estimated benefit over cost

Project evaluation is done by expert groups. It involves two steps (a) estimation of benefits and costs,
the benefits and costs must be measure in terms of cash flow, and (b) selection of appropriate criterion
to judge the viability of the project

While evaluating a project the risk associated with it should also be properly handled, and should be
taken into account in the decision process. All care must be taken in selecting criterion to judge the
projects viability. As far as possible, the criterion should be consistent with the firm’s objective of
maximizing its market value. To achieve this purpose, time value of money must be recognized.

Project selection

No standard administrative procedure can be laid down for selecting the project and approving the
investment proposal. The screening and selection procedure may vary from firm to firm. Since the
capital budgeting decisions are of considerable significance for several reasons, the final approval of the
project may generally rest on top management. However, projects are screened at multiple levels.
Sometimes the top management may delegate authority to approve certain type of investment proposals.

Project execution

After the final selection of the investment proposal the funds are appropriated for capital expenditure.
The formal plan for appropriation of funds is called capital budget. Such plans ate prepared or approved
by the project execution committee or the top management.

The project execution committee or the top management must ensure that funds are spent in accordance
with the appropriation made in the capital budget. Funds for the purpose of project execution must be
spent only after seeking formal permission from the controller. For effective control, monthly budget
reports is prepared to show clearly the amount appropriated, amount spent, and amount not spend.

Er. Santosh Kr.Shrestha Er. Ishwar Adhikari

Systematic procedure is needed to review the project during its ongoing process and also after
completion. The follow-up comparison of actual performance with original estimates not only ensures
for improving future forecasts.

6.3 investment decision criteria

As the capital budgeting decision is of utmost importance, a sound appraisal method should be adopted
to measure the economic worth of each investment project. For this a set of evaluation criteria should
be used having following characterizes.

1. It should provide a ranking of projects in order of their desirability

2. It should also solve the problem of choosing among alternative projects
3. It should be a criterion which is acceptable to any conceivable investment projects
4. It should recognize the fact that bigger benefit is preferable to smaller ones, and early benefits
are preferable to later benefits
5. It should provide a means of distinguishing between acceptable and unacceptable projects

There are a number of investment criteria. The most important criteria that are in use are grouped in to
following two categories, which are further sub categorized as below.

A. Traditional criteria.
a. Payback period

I. Simple payback period

II. Discounted payback period

b. Accounting rate of return

B. Discounted cash flow criteria

a. Net present value/net future value/net annual value

b. IRR

Er. Santosh Kr.Shrestha Er. Ishwar Adhikari

 c. Profitability index or B/C ratio

Different criteria may use by different firms for the investment judgement. The selection of particularly
criteria may depends on various circumstances. Large company may use more than one technique to
appraise each of its investment projects. While a small firm may use only a single technique which
involves minimum fund time. However, to avoid confusion, same method(s) should be used uniformly
for all projects.

6.3.1 Payback period

The payback period is one of the most popular and widely recognized traditional methods of evaluating
investment proposals. It is defined as the number of years required to recover the original cash outlay
invested in a project if the project generates constant annual cash inflows, the payback period can be
computed dividing cash outlay by the annual cash inflow. That is:

Payback period: cash outlay (investment)/ annual cash flow

i.e. C/A

if the annual cash flow is unequal, the total payback period can be found out by adding up the cash
inflow until the total is equal to the initial cash outlay

Advantages of payback period

1. Simple to understand and easy to calculate

2. It costs less than most of the sophisticated techniques which requires lots of analysis time and
the use of computers
3. A company can have more favourable short run effect on earnings per share by setting up a
shorter payback period
4. The riskiness of the project can be tackled by having the shorter payback period as it may ensure
guarantee against loss
5. The emphasis in payback is on the early recovery of the investment. Thus, it gives an insight to
the liquidity of the project. The funds so released can be put to other uses.

Er. Santosh Kr.Shrestha Er. Ishwar Adhikari

Disadvantages of payback period

1. It fails to take account of the cash inflow earned after the payback period
2. It does not consider the entire cash inflow yielded by the project
3. Fails to consider the pattern of cash inflow in terms of magnitude and time
4. Administrative difficulties may be faced in determining the maximum acceptable payback
period
5. Payback period method is not consistent with the objective of maximizing the market value of
the firms’ share

Acceptance value

The payback period can be used as an accept or reject criterion as well as a method of ranking projects.
If the payback period calculated for a project is less than the maximum payback period set up by the
management, it would be accepted; if not, it would be rejected. As a ranking method, it gives highest
ranking to the project which has shortest payback period and lowest ranking to the project with highest
payback period. Thus, if the firm has to choose among two mutually exclusive projects, project with
shorter payback period will be selected.

Example 6.1

A project requires an outlay of Rs 50,000 and yields an annual cash flow of Rs 12,500 for 7 years.
Calculate the payback period.

Solution

Pay back period for the project is = 50,000/12,500 = 4 years

Example 6.2

Er. Santosh Kr.Shrestha Er. Ishwar Adhikari

Calculate the payback period for a project which requires a cash outlay of Rs 20,000 and generates cash
inflow of Rs 8,000; Rs 7,000; Rs 4000 and Rs 3,000

solution

Cash inflow of the first 3 years= Rs 8000; Rs 7000; Rs 4000 = Rs 19000

In the fourth year, amount to be received = 20,000-19,000 = 1000

Actual inflow in the fourth year = 3000

So, the payback period = (1000/3000) *12 months = 4 months

So net payback period is 3 years and 4 months

Example 6.3

Calculate the payback period of the following projects each requires a cash outlay of Rs 10,000. Suggest
which ones are acceptable if the standard payback period is 5 years

Cash inflows
Year Project X Project Y Project Z
1 Rs 2500 Rs 4000 Rs 1000
2 Rs 2500 Rs 3000 Rs 2000
3 Rs 2500 Rs 2000 Rs 3000
4 Rs 2500 Rs 1000 Rs 4000
5 Rs 2500 0 0

Payback period:

Er. Santosh Kr.Shrestha Er. Ishwar Adhikari

For project X: Rs10,000/Rs2500 = 4 years

For project Y: Rs 4000+3000+2000+1000 = 10,000 recovered in 4years

For project Z: Rs 1000+2000+3000+4000 = 10,000 recovered in 4years

6.3.2 Accounting rate of return (ARR) method

The accounting rate of return is obtained by dividing the average income after taxes by the average
investment

𝐚𝐯𝐞𝐫𝐚𝐠𝐞 𝐢𝐧𝐜𝐨𝐦𝐞
𝐀𝐑𝐑 =
𝐚𝐯𝐞𝐫𝐚𝐠𝐞 𝐢𝐧𝐯𝐞𝐬𝐭𝐦𝐞𝐧𝐭

(𝑖𝑛𝑐𝑜𝑚𝑒 − 𝑒𝑥𝑝𝑒𝑛𝑠𝑒𝑠 − 𝑡𝑎𝑥𝑒𝑠)

𝑎𝑣𝑒𝑟𝑎𝑔𝑒 𝑖𝑛𝑐𝑜𝑚𝑒 =
𝑛𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑦𝑒𝑎𝑟𝑠

( 𝑜𝑟𝑖𝑔𝑖𝑛𝑎𝑙 𝑖𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡+𝑠𝑎𝑙𝑣𝑎𝑔𝑒 𝑜𝑟 𝑠𝑐𝑟𝑎𝑝 𝑣𝑎𝑙𝑢𝑒)

𝑎𝑣𝑒𝑟𝑎𝑔𝑒 𝑖𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡 = 2

Advantages of ARR

1. Simple to understand and easy to calculate

2. It costs less than most of the sophisticated techniques which requires lots of analysis time and
the use of computers
3. It can be readily calculated using the accounting data
4. It uses the entire stream of income in calculating the accounting rate

Disadvantages of ARR method

1. It ignores the time value of money. Profit occurring in different periods are valued equally
2. It uses accounting profit, not cash flows in appraising the project

Er. Santosh Kr.Shrestha Er. Ishwar Adhikari

 3. It does not consider the length of project lives
4. It does not allow the fact that the profit can be re-invested
5. It is incompatible with the firms’ objective of maximizing the market value of the share. Share
value does not depend on the accounting rate

Acceptance rule

 Accept the project proposal, if ARR is more than the minimum rate established by the
management (i.e. if ARR > minimum rate)
 Reject the proposal, if ARR is less than the minimum rate established by the management (i.e.
ARR < minimum rate)

Example 6.4

A project costs Rs 50,000 and has a scrap value of Rs 10,000. Its stream of income before
depreciation and taxes during first year through five years is Rs 10,000 Rs 12,000, Rs 14,000 Rs
16,000 and Rs 20,000. Assume 50% tax rate depreciation on straight line basis. Calculate ARR of
the project.

Solution

Initial investment =Rs 50,000

Scrap value = Rs 10000

Total depreciation = Rs50,000-Rs 10,000 = Rs 40,000

Number of years = 5 years

Depreciation per year = 40000/5 = Rs 8000

Year 1 Year 2 Year 3 Year 4 Year 5

Er. Santosh Kr.Shrestha Er. Ishwar Adhikari

 (a)Income (Rs) 10,000 12000 14000 16000 18000
(b)Depreciation 8000 8000 8000 8000 8000
(Rs)
(c) gross 2000 4000 6000 8000 10000
income (a-b)
(d) tax 50% 1000 2000 3000 4000 5000

(e) net income 1000 2000 3000 4000 5000

6.3.3 Net present value (NPV) method

The net present value method is the classic economic method of evaluating the investment proposal.
It is one of the discounted cash flow techniques. It recognizes the time value of the money.

In this method, first the present value of the cash inflow and the present value of cash out flow are
computed separately. NPV is the difference between these two present values.

1𝐶 2 𝐶 𝐶
3 𝐶
4 𝑛𝐶
𝑃𝑉 = [((1+𝐾)1 ) + ((1+𝐾)2 ) + ((1+𝐾)3 ) + ((1+𝐾)4 ) + ⋯ + ((1+𝐾)𝑛 )]

Where:

 𝐶1 𝐶2 𝐶3 ….𝐶𝑛 represent cash inflow or outflow in the year 1,2,3…. n

 n is the life of the project, and k is the discount rate

NPV = PV of cash inflow – PV of cash out flow

Advantages

Er. Santosh Kr.Shrestha Er. Ishwar Adhikari

  considers all cash flow
 true measure of profitability
 recognizes the time value of money

Disadvantages

 requires estimation of cash inflow and outflow which is a tedious job

 sensitive to discount rate
 requires computation of the opportunity cost of the capital or (firms’ cost of capital)/MARR,
which are difficult concept

Acceptance

Accept, if NPV is positive (i.e. NPV >0)

Reject if NPV is negative (i.e. NPV < 0)

6.2.4 Internal rate of return

The internal rate of return (IRR) is another classic economic method of evaluating the investment
proposal. It is one of the discounted cash flow techniques. It recognizes the time value of the money.

The internal rate of return can be defined as the that rate which equates the present value of cash inflow
with the present value of cash outflow of an investment. In other words, it is that rate at which the Net
Present Value (NPV) is zero.

IRR needs to be computed following the trial and error method. In this method, first a discount rate is
assumed and the present value of both cash inflow and cash outflow are computed separately. The
differences between these two present values are noted. Accordingly, the discounted rate is adjusted in
such a way that the present value of both the cash inflow and cash outflow becomes same. This discount
rate is IRR.

So, the equation to be used here is same as that of the Net Present Value (NPV) method.

Er. Santosh Kr.Shrestha Er. Ishwar Adhikari

Advantages

 Consider all cash flows

 True measure of profitability

 Recognizes the time value of money

 Consistent with the wealth maximisation principle

Disadvantages

 Requires estimation of cash inflow and outflow, which is a tedious job

 It is difficult to understand and use in practice as it involves complicated computation problems.

Acceptance

Accept, if IRR is more than normal bank rate or investors' rate (IRR >= MARR)

Reject, if IRR is less than normal bank rate or investors’ rate. (IRR <=MARR)

6.2.5 Profitability Index (PI) or B/C ratio

Profitability index (or B/C ratio) is the ratio of the present value of the future inflow at the required rate
of return to the present value of cash outflow.

Profitability index (or B/C ratio) = (PV of the future cash inflow)/ (PV of investment)

It’s advantages and disadvantages are similar to NPV and IRR methods.

Acceptance

Accept, if PI or BC ratio is more than one (BCR >=1)

Er. Santosh Kr.Shrestha Er. Ishwar Adhikari

Reject, if PI or BC ratio is less than one (BCR<=1)

Example 4.5

Project Investment Annual cash flow (Rs) Life in years

A 10000 4000 12
B 25000 10000 4
C 30000 6000 20
D 35000 12000 16

Solution

Payback period

𝑖𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡 10000
𝑝𝑟𝑜𝑗𝑒𝑐𝑡 𝐴 = = = 2.5 𝑦𝑒𝑎𝑟𝑠
𝑎𝑛𝑛𝑢𝑎𝑙 𝑐𝑎𝑠ℎ 𝑓𝑙𝑜𝑤 4000

𝑖𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡 25000
𝑝𝑟𝑜𝑗𝑒𝑐𝑡 𝐵 = = = 2.5 𝑦𝑒𝑎𝑟𝑠
𝑎𝑛𝑛𝑢𝑎𝑙 𝑐𝑎𝑠ℎ 𝑓𝑙𝑜𝑤 10000

𝑖𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡 30000
𝑝𝑟𝑜𝑗𝑒𝑐𝑡 𝐶 = = = 5 𝑦𝑒𝑎𝑟𝑠
𝑎𝑛𝑛𝑢𝑎𝑙 𝑐𝑎𝑠ℎ 𝑓𝑙𝑜𝑤 6000

𝑖𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡 35000
𝑝𝑟𝑜𝑗𝑒𝑐𝑡 𝐷 = = = 2.91 𝑦𝑒𝑎𝑟𝑠
𝑎𝑛𝑛𝑢𝑎𝑙 𝑐𝑎𝑠ℎ 𝑓𝑙𝑜𝑤 12000

Er. Santosh Kr.Shrestha Er. Ishwar Adhikari

Project Investment Annual cash flow (Rs) Life in years
A 10000 4000 12
B 25000 10000 4
C 30000 6000 20
D 35000 12000 16

Net present value

(1+𝑖)𝑁 −1 (1+0.1)12 −1
𝑝𝑟𝑒𝑠𝑒𝑛𝑡 𝑣𝑎𝑙𝑢𝑒 𝑜𝑓 𝑏𝑒𝑛𝑒𝑓𝑖𝑡 𝑜𝑓 𝑝𝑟𝑜𝑗𝑒𝑐𝑡 𝐴 = 𝐴 ∗ 𝑖(1+𝑖)𝑁
= 4000 ∗ 0.1(1+0.1)12 = 𝑅𝑠 27254.76

𝑛𝑒𝑡 𝑝𝑟𝑒𝑠𝑒𝑛𝑡 𝑣𝑎𝑙𝑢𝑒 𝑜𝑓 𝑝𝑟𝑜𝑗𝑒𝑐𝑡 𝐴 = 𝑅𝑠 27254.76 − 𝑅𝑠 10000 = 𝑅𝑠 17254.76

(1+𝑖)𝑁 −1 (1+0.1)4 −1
𝑝𝑟𝑒𝑠𝑒𝑛𝑡 𝑣𝑎𝑙𝑢𝑒 𝑜𝑓 𝑏𝑒𝑛𝑒𝑓𝑖𝑡 𝑜𝑓 𝑝𝑟𝑜𝑗𝑒𝑐𝑡 𝐵 = 𝐴 ∗ = 10000 ∗ = 𝑅𝑠 31698.65
𝑖(1+𝑖)𝑁 0.1(1+0.1)4

𝑛𝑒𝑡 𝑝𝑟𝑒𝑠𝑒𝑛𝑡 𝑣𝑎𝑙𝑢𝑒 𝑜𝑓 𝑝𝑟𝑜𝑗𝑒𝑐𝑡 𝐵 = 𝑅𝑠 31698.65 − 𝑅𝑠 25000 = 𝑅𝑠 6698.65

(1 + 𝑖)𝑁 − 1 (1 + 0.1)20 − 1
𝑝𝑟𝑒𝑠𝑒𝑛𝑡 𝑣𝑎𝑙𝑢𝑒 𝑜𝑓 𝑏𝑒𝑛𝑒𝑓𝑖𝑡 𝑜𝑓 𝑝𝑟𝑜𝑗𝑒𝑐𝑡 𝐶 = 𝐴 ∗ = 6000 ∗
𝑖(1 + 𝑖)𝑁 0.1(1 + 0.1)20

= 𝑅𝑠 51081.38

𝑛𝑒𝑡 𝑝𝑟𝑒𝑠𝑒𝑛𝑡 𝑣𝑎𝑙𝑢𝑒 𝑜𝑓 𝑝𝑟𝑜𝑗𝑒𝑐𝑡 𝐶 = 𝑅𝑠 51081.38 − 𝑅𝑠 30000 = 𝑅𝑠 21081.38

(1+𝑖)𝑁 −1 (1+0.1)16 −1
𝑝𝑟𝑒𝑠𝑒𝑛𝑡 𝑣𝑎𝑙𝑢𝑒 𝑜𝑓 𝑏𝑒𝑛𝑒𝑓𝑖𝑡 𝑜𝑓 𝑝𝑟𝑜𝑗𝑒𝑐𝑡 𝐷 = 𝐴 ∗ 𝑖(1+𝑖)𝑁
= 4000 ∗ 0.1(1+0.1)16 = 𝑅𝑠 93884.50

𝑛𝑒𝑡 𝑝𝑟𝑒𝑠𝑒𝑛𝑡 𝑣𝑎𝑙𝑢𝑒 𝑜𝑓 𝑝𝑟𝑜𝑗𝑒𝑐𝑡 𝐷 = 𝑅𝑠 93884.5 − 𝑅𝑠 35000 = 𝑅𝑠 58884.5

Er. Santosh Kr.Shrestha Er. Ishwar Adhikari

 B/C ratio
𝑝𝑟𝑒𝑠𝑒𝑛𝑡 𝑣𝑎𝑙𝑢𝑒 𝑜𝑓 𝑏𝑒𝑛𝑒𝑓𝑖𝑡𝑠 27254.76
𝑝𝑟𝑜𝑗𝑒𝑐𝑡 𝐴 = = = 2.72
𝑖𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡 10000

𝑝𝑟𝑒𝑠𝑒𝑛𝑡 𝑣𝑎𝑙𝑢𝑒 𝑜𝑓 𝑏𝑒𝑛𝑒𝑓𝑖𝑡𝑠 31698.65

𝑝𝑟𝑜𝑗𝑒𝑐𝑡 𝐵 = = = 1.267
𝑖𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡 25000

𝑝𝑟𝑒𝑠𝑒𝑛𝑡 𝑣𝑎𝑙𝑢𝑒 𝑜𝑓 𝑏𝑒𝑛𝑒𝑓𝑖𝑡𝑠 51081.38

𝑝𝑟𝑜𝑗𝑒𝑐𝑡 𝐶 = = = 1.267
𝑖𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡 30000

𝑝𝑟𝑒𝑠𝑒𝑛𝑡 𝑣𝑎𝑙𝑢𝑒 𝑜𝑓 𝑏𝑒𝑛𝑒𝑓𝑖𝑡𝑠 93884.5

𝑝𝑟𝑜𝑗𝑒𝑐𝑡 𝐷 = = = 2.68
𝑖𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡 35000

Er. Santosh Kr.Shrestha Er. Ishwar Adhikari

 IRR method
Project A

(1+𝑖)12 −1
𝑃𝑊𝑖𝑛𝑓𝑙𝑜𝑤 − 𝑃𝑊𝑜𝑢𝑡𝑓𝑙𝑜𝑤 = 0 OR − 10000 = 0; 𝑖 (𝐼𝑅𝑅) = 39.24%
𝑖(1+𝑖)12

Project B

(1 + 𝑖)4 − 1
𝑃𝑊𝑖𝑛𝑓𝑙𝑜𝑤 − 𝑃𝑊𝑜𝑢𝑡𝑓𝑙𝑜𝑤 = 0; − 25000 = 0; 𝑖 (𝐼𝑅𝑅) = 21.86%
𝑖(1 + 𝑖)4

Project C

(1 + 𝑖)20 − 1
𝑃𝑊𝑖𝑛𝑓𝑙𝑜𝑤 − 𝑃𝑊𝑜𝑢𝑡𝑓𝑙𝑜𝑤 = 0; − 30000 = 0 𝑖 (𝐼𝑅𝑅) = 19.24%
𝑖(1 + 𝑖)20

Project D

(1+𝑖)16 −1
𝑃𝑊𝑖𝑛𝑓𝑙𝑜𝑤 − 𝑃𝑊𝑜𝑢𝑡𝑓𝑙𝑜𝑤 = 0; 𝑖(1+𝑖)16
− 35000 = 0; 𝑖 (𝐼𝑅𝑅) = 33.96%

Er. Santosh Kr.Shrestha Er. Ishwar Adhikari

 ARR method
Here no salvage value is provided therefore we take it as zero

Project A

𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑖𝑛𝑐𝑜𝑚𝑒
𝐴𝑅𝑅 =
𝑎𝑣𝑒𝑟𝑎𝑔𝑒 𝑖𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡

10000 + 0
𝑎𝑣𝑒𝑟𝑎𝑔𝑒 𝑖𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡 = = 5000
2

𝟒𝟎𝟎𝟎
𝑨𝑹𝑹 = 𝟓𝟎𝟎𝟎 =0.8 (80%)

Project B

𝑖𝑛𝑐𝑜𝑚𝑒
𝐴𝑅𝑅 = 𝑎𝑣𝑒𝑟𝑎𝑔𝑒
𝑎𝑣𝑒𝑟𝑎𝑔𝑒 𝑖𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡

25000 + 0
𝑎𝑣𝑒𝑟𝑎𝑔𝑒 𝑖𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡 = = 12500
2

𝟏𝟎𝟎𝟎𝟎
𝑨𝑹𝑹 (𝑩) = =0.8 (80%)
𝟏𝟐𝟓𝟎𝟎

Project C

𝑖𝑛𝑐𝑜𝑚𝑒
𝐴𝑅𝑅 = 𝑎𝑣𝑒𝑟𝑎𝑔𝑒
𝑎𝑣𝑒𝑟𝑎𝑔𝑒 𝑖𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡

30000 + 0
𝑎𝑣𝑒𝑟𝑎𝑔𝑒 𝑖𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡 = = 15000
2

Er. Santosh Kr.Shrestha Er. Ishwar Adhikari

 6000
𝐴𝑅𝑅 (𝐶) = 15000 =0.4 (40%)

Project D

𝑖𝑛𝑐𝑜𝑚𝑒
𝐴𝑅𝑅 = 𝑎𝑣𝑒𝑟𝑎𝑔𝑒
𝑎𝑣𝑒𝑟𝑎𝑔𝑒 𝑖𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡

35000 + 0
𝑎𝑣𝑒𝑟𝑎𝑔𝑒 𝑖𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡 = = 17500
2

12000
𝐴𝑅𝑅 (𝐷) = 17500 =0.68 (68%)

Ranking
Project PB NPV IRR B/C ARR
A 1 3 1 1 1
B 1 4 3 4 1
C 3 2 4 3 3
D 2 1 2 2 2

Er. Santosh Kr.Shrestha Er. Ishwar Adhikari

6.4 CAPITAL STRUCTURE PLANNING

6.4.1 Definition of terms

1. Capital: Capital is a term describing wealth, which may be utilized to economic advantages.
Cash, land, equipment, raw material, finished products, human etc are the form of such capital.

2. Equity capital: Equity capital (common share) is supplied and used by its owner in the
expectations that a profit will be earned. There is no assurance that a profit will, in fact, be
gained or that the invested capital will be recovered. Likewise, there are no limitations placed
on the use of funds except those imposed by the owner themselves.

3. Debt capital: Debt capital is the borrowed Capital. When borrowed funds are used, fixed rate
of interest must be paid to the suppliers of the capital, and the debt must be repaid at a specified
time. The borrower of the debt does not share the profits resulting from the use of the capital.

4. Bond: A bond is essentially a long-term note given to lender by the borrower, stipulating the
terms of re- payment and other conditions. Usually, bonds are issues in unit of Rs 100 each.
With a defined rate of interest. So, basically, this is long term debt.

5. Debentures: A debenture is a bond issued without any collateral. It is also known as unsecured
bond. Thus, debenture holders are the general creditor of the company. A company having
strong credit position and highly profitable investment, and high amount of assets issue
debenture. Bonds issued by Himalayan Bank Limited and Investment Bank Limited are example
of debenture.

6. Preference share capital: Preference share capital is that capital which has the characteristics
of both the equity capital and debt capital. Two types of dividends are provided to preference
shareholders. They are: (a) dividends based on fixed percentage (debt capital), which is paid
after tax deduction, (b) dividends based on earning (like the one paid to equity shareholders).
So, this is more like long term debt, and some time referred to as hybrid capital. Like, equity
shareholders, preference shareholders are also considered as owner of the firm, but they do not
enjoy any of the voting rights of the equity shareholders.

Er. Santosh Kr.Shrestha Er. Ishwar Adhikari

In the case of preference share capital, dividends (based on fixed percentage) are paid from after tax
profit. But, in case of the debt or bond, interests (dividends) are paid from pre-tax profit. Therefore,
preference share capital is most costly.

Capital structure, sometime known as financial plan (Capital plan or Financial Plan) refers to the
composition (makeup) of long-term sources of fund, such as debentures, long term debt, preference
share Capital, and equity share capital including reserve and surplus. Some companies do not plan their
capital structure and it develops as a result it the financial decision taken by the financial manager
without any formal planning. Such companies may prosper in short term, but ultimately will face
considerable difficulties in raising funds to finance their activities. With unplanned capital structure,
organisation may also fail to economies the use of their funds. Consequently, it is being increasingly
realized that an organisation should plan its capital structure to maximize the use of funds and to be able
to adapt more easily to the changing conditions.

While planning capital structure, one needs to decide on the following aspects:

 Long term debt

 Bond

 Promoters'/Investors investment (equity share)

In practise, the determination of an optimum capital structure is a formidable task, and one has to go
beyond the theory. A number of factors influence the capital structure decision. The judgement of a
person taking the capital structure decision plays the most crucial part. Thus, two similar projects can
have two different capital structure depending on the knowledge and risk-taking capacity of the decision
makers.

Er. Santosh Kr.Shrestha Er. Ishwar Adhikari

 6.4.2 Basic for planning capital structure

Planning of capital structure should be done in such way that long -term market price share should
be maximized and interest of different group of people is to be met.

 Promoters / investors (equity shareholders)

 Creditors
 Employees
 Society and government

In general, a capital structure is said to be appropriate when the debt- capital ratio varies between
45 and 75 (60±15%)

Er. Santosh Kr.Shrestha Er. Ishwar Adhikari

 6.4.3 Important features of a sound capital structure
a sound or appropriate capital structure should have following features

Profitability:

The capital structure of the company should be most advantageous. Within the constraints, maximum
use of leverage (influence on ESP caused by debt or preference share capital, and equity share) at a
minimum cost should be made

Solvency:

The use of excessive debt threatens the solvency of the company. Debt should be added only point up
to a level which does not added substantial risk to the company

Flexibility:

Flexibility means the firm’s ability to decide on its capital structure to meet its dynamic need. So, the
company capital structure should be flexible enough to meet the dynamic need of the company. Further,
the company should be able to adopt its capital structure without undue delay and cost.

Conservatism:

Conservation deals with cash flow ability of the company. To some extent the capital structure of a firm
should also be conservative in the sense that the debt capacity of the company should not be exceeded.
The debt capacity of a company of a company depends on its ability to generate future cash flow.

Control:

The capital structure should involve minimum risk of loss of control of the company. In other word
capital structure should be planned in such a way that the company should always be able to keep control
on it.

Er. Santosh Kr.Shrestha Er. Ishwar Adhikari

For example, in designing the capital structure, sometime the existing management does not want to
lose its control over the company, especially from the perspective of both the governance and
management. So, they may wish to have small and ordinary shareholders. Such share holders are widely
scattered, and most of them are not interested in taking active part in the company’s management. They
do not have time and money to attend the meetings. They are simply interested in dividends and the
price of the share. If they are not satisfied with the management of the company, they will sell their
shares. Thus, the best way to ensure control and to have the confidence of the share holders is to manage
the company most efficiently. The risk of loss of control can be reduced by distributing shares widely
and in small lots.

These are the general features of a sound capital structure. Sometimes depending on the characteristics
of a company, we may need to consider some additional features for a sound capital structure. Further
emphasis give to above features may vary from company to company.

Er. Santosh Kr.Shrestha Er. Ishwar Adhikari

 6.4.4 Determinants of the capital structure

A firm should plan its capital structure to maximize the use of the fund, and to be able to adopt more
easily to the changing conditions. The capital structure has to be planned initially at the time a
company is promoted. The initial capital structure should be designed very carefully. With the
improper or unplanned capital structure, firms will fail to economies the use of their funds. So, a
firm should first set a target capital structures and the subsequent financing decisions should be
made with a view to achieve the targeted capital structures.

Generally, the following factors should be considered whenever a capital structure decision has to
be taken. These are the additional factors (or features) other than that mentioned above in features
of sound capital structures.

1. Leverage effect on earnings per share

2. Growth and stability of sales
3. Cost of capital
4. Size of the company
5. Marketability, and
6. Flotation costs

These features are discussed below.

1. Leverage effect on earnings per share

The use of fixed cost source of finance, such as debt or preference share capital, to finance the
assets of the company is known as financial leverage or trading on equity. Influence on EPS
when debt or preference share capital is used against equity share capital is leverage effect. Such
leverage impact is realized mainly due to following characteristics of the debt and preference
share capitals

i. Cost of debt is usually lower than the cost of preference share capital
ii. Interest paid on debt or bond is from pre tax profit. While interest (dividends paid on
the basis of fixed percentage) paid on preference share capital is from after tax profit.

Er. Santosh Kr.Shrestha Er. Ishwar Adhikari

This is explained below:

Dictionary meaning of leverage is influence, force or weight. Whenever there is an investment,

irrespective of its type (equity, debt, preference share etc), certain earning per share (EPS) is expected.
But, this earning per shares varies with the type of investment, mainly due to above noted investment
characteristics. This influence on EPS caused by the debt or preference share capital in comparison (in
trading) with the equity share capital is termed as leverage effect on EPS.

2. Growth and stability of sales

A company’s capital structure is also shaped by the growth and stability of sales. A firm having
stables sales can employ large amount of debt (high degree of leverage), because they will not face
difficulty in paying back the debt. For example, usually the sales of the consumer goods industries
show wide fluctuations; therefore, they do not employ a large amount of debt. On the other hand,
the sales of public utilities are quite stable and predictable. Public utilities, therefore, employ a large
amount of debt to finance their assets.

Similar is the situation with the expected growth in sales. A company expected to have larger growth
of sales can employ larger debt.

3. Cost of capital
Capital structure of a firm is also shaped by the cost of the capital. This means a company may
employ cheaper capital. Usually, debt is a cheaper source of funds than equity. This is generally the
case even when taxes are considered. The tax deductibility of interest charges further reduces the
cost of debt.

It should, however, be realized that a company cannot continuously minimize its overall cost of
capital by employing debt. A point or range is reached beyond which debt becomes expensive
because of the increased risk of excessive debt to creditors increases and they demand a higher
interest rate and do not grant loan to the company at all once its debt has reached a particular level.

4. Size of the company

Er. Santosh Kr.Shrestha Er. Ishwar Adhikari

 The size of the company greatly influences the availability of funds from different sources. A small
company finds great difficulty in raising long term loans. If it is able to obtain some long-term loan,
it will be available at a higher rate of interest and inconvenient terms. The highly restrictive
covenants in loan agreements in case of small companies make their capital structure capital
structures very inflexible and management cannot run business freely without any interference.
Small companies, therefore, depends on share capital and retained earnings for their long term finds

A large company has a greater degree of flexibility in designing its capital structure. It can obtain
loans at easy term and sell common shares; preferences share and debentures to the public.

5. Marketability
Marketability means the readiness of investors to purchase a particular type of security in a given
periods of time. Marketability does not influence the initial capital structure, but is an important
consideration to decide about the appropriate timing of security issues. The capital markets are
changing continuously. This is explained below.

If the share market is depressed, the company should not issue common shares, but issue debt and
wait to issue common shares till the share market revives.

6. Floatation costs
Floatation costs are not a very important factor influencing the capital structure of a company.
Floatation costs are incurred only when the funds are raised. Generally, the cost of floatation a
debt is less than a cost of floating an equity issue. This nay encourages a company to use debt
than issue common shares.

Er. Santosh Kr.Shrestha Er. Ishwar Adhikari

 Example 6.5

A firm has total capital of Rs 10,00,000 which consists of 3000 ordinary shares @ Rs 100 per shares,
Rs 200,000 preferences share at 10% interest per year and Rs 5,00,000 debts at 12% interest per year. If
firm’s earning before interest and tax are Rs 2,50,000 and tax rate applicable is 30%, determine earning
per share.

Solution

𝑜𝑟𝑑𝑖𝑛𝑎𝑟𝑦 𝑠ℎ𝑎𝑟𝑒 = 3000@𝑅𝑠 100

𝑝𝑟𝑒𝑓𝑒𝑟𝑒𝑛𝑐𝑒 𝑠ℎ𝑎𝑟𝑒 = 2,00,000@10% 𝑝𝑒𝑟 𝑦𝑒𝑎𝑟

𝑑𝑒𝑏𝑡 𝑐𝑎𝑝𝑖𝑡𝑎𝑙 = 5,00,000@12%𝑝𝑒𝑟 𝑦𝑒𝑎𝑟

a) 𝑓𝑖𝑟𝑚′ 𝑠 𝑒𝑎𝑟𝑛𝑖𝑛𝑔 𝑏𝑒𝑓𝑜𝑟𝑒 𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑎𝑛𝑑 𝑡𝑎𝑥(𝐸𝐵𝐼𝑇) = 2,50,000

b) 𝑖𝑛𝑡𝑒𝑟𝑠𝑡 𝑜𝑛 𝑙𝑜𝑎𝑛 = 12% 𝑜𝑓 𝑅𝑠 5,00,000 = 60,000
c) 𝑒𝑎𝑟𝑛𝑖𝑛𝑔 𝑎𝑓𝑡𝑒𝑟 𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑏𝑒𝑓𝑜𝑟𝑒 𝑡𝑎𝑥 (𝐸𝐴𝐼𝐵𝑇) = (𝑎 − 𝑏) = 1,90,000
d) 𝑡𝑎𝑥 @30% 𝑜𝑓 𝐸𝐴𝐼𝐵𝑇 = 57,000
e) 𝑒𝑎𝑟𝑛𝑖𝑛𝑔 𝑎𝑓𝑡𝑒𝑟 𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑎𝑛𝑑 𝑡𝑎𝑥 (𝐸𝐴𝐼𝑇) = 133,000
f) 𝑖𝑛𝑡𝑒𝑟𝑠𝑡(𝑑𝑖𝑣𝑖𝑑𝑒𝑛𝑑) 𝑡𝑜 𝑝𝑟𝑒𝑓𝑒𝑟𝑒𝑛𝑐𝑒 𝑠ℎ𝑎𝑟𝑒 ℎ𝑜𝑙𝑑𝑒𝑟𝑠 = 10% 𝑜𝑓 2,00,000
g) 𝑑𝑖𝑣𝑖𝑑𝑒𝑛𝑑𝑠 𝑡𝑜 𝑜𝑟𝑑𝑖𝑛𝑎𝑟𝑦 𝑠ℎ𝑎𝑟𝑒 ℎ𝑜𝑙𝑑𝑒𝑟𝑠 = (𝑒 − 𝑓) = 1,13,000
1,13,000
h) 𝑒𝑎𝑟𝑖𝑛𝑔 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒 (𝐸𝑃𝑆) = 3000
= 37.67

Er. Santosh Kr.Shrestha Er. Ishwar Adhikari

Example 6.6

A firm has equity capital consisting of 4000 ordinary shares @Rs 100 per share and loan of Rs 8,00,000
borrowed at an interest rate of 10% per year. The firm wants to raise Rs 10,00,000 to finance its
investment and is considering two alternative methods of financing i.e. i) to issue 4,000 common shares
@100 each and to borrow Rs6,00,000 at 12% interest and ii) to issue 2000 common shares @Rs100; to
issue 3,00,000 preference share at an interest rate of 10% and to borrow Rs 5,00,000 at 12% interest. If
the firm’s earning before interest and tax is Rs 3,50,000 and the tax rate applicable is 30%, determine
earning per share to decide on the alternatives.

Solution

Existing capital structure

4000 ordinary shares @Rs 100 per share

Rs 8,00,000 loan @10% interest per year

Additional capital required is Rs 10,00,000

Option 1

4000 common (ordinary) shares @Rs 100

Rs 6,00,000 loan @12% interest per year

Option 2

2000 common (ordinary) shares @Rs 100

Rs 3,00,000 preference shares @10% interest per year and Rs 5,00,000 loan @12% interest per year

Er. Santosh Kr.Shrestha Er. Ishwar Adhikari

Total capital structure of option 1

𝑜𝑟𝑑𝑖𝑛𝑎𝑟𝑦 𝑠ℎ𝑎𝑟𝑒 = 4000 + 4000 = 8000@𝑅𝑠 100

Rs 8,00,000 loan @10% per year and Rs 6,00,000 loan @12% interest per year

Calculation:

a) 𝑒𝑎𝑟𝑛𝑖𝑛𝑔 𝑏𝑒𝑓𝑜𝑟𝑒 𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑎𝑛𝑑 𝑡𝑎𝑥 (𝐸𝐵𝐼𝑇) = 𝑅𝑠 3,50,000

b) 𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑜𝑛 𝑙𝑜𝑎𝑛 = 10% 𝑜𝑓 8,00,000 + 12% 𝑜𝑓 6,00,000 = 𝑅𝑠 152,000
c) 𝑒𝑎𝑟𝑛𝑖𝑛𝑔 𝑎𝑓𝑡𝑒𝑟 𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑏𝑒𝑓𝑜𝑟𝑒 𝑡𝑎𝑥 (𝐸𝐴𝐼𝐵𝑇) = (𝑎 − 𝑏) = 1,98,000
d) 𝑡𝑎𝑥 @30% 𝑜𝑓 𝐸𝐴𝐼𝐵𝑇 = 59400
e) 𝑒𝑎𝑟𝑛𝑖𝑛𝑔 𝑎𝑓𝑡𝑒𝑟 𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑎𝑛𝑑 𝑡𝑎𝑥 (𝐸𝐴𝐼𝑇)(𝑐 − 𝑑) = 1,38,600
f) 𝑖𝑛𝑡𝑒𝑟𝑠𝑡(𝑑𝑖𝑣𝑖𝑑𝑒𝑛𝑑) 𝑡𝑜 𝑝𝑟𝑒𝑓𝑒𝑟𝑒𝑛𝑐𝑒 𝑠ℎ𝑎𝑟𝑒 ℎ𝑜𝑙𝑑𝑒𝑟𝑠 = 0
g) 𝑑𝑖𝑣𝑖𝑑𝑒𝑛𝑑𝑠 𝑡𝑜 𝑒𝑞𝑢𝑖𝑡𝑦 𝑠ℎ𝑎𝑟𝑒 ℎ𝑜𝑙𝑑𝑒𝑟𝑠 = 1,38,600
1,38,600
h) 𝑒𝑎𝑟𝑖𝑛𝑔 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒 (𝐸𝑃𝑆) = = 𝑅𝑠 17.32
8000

Er. Santosh Kr.Shrestha Er. Ishwar Adhikari

Total capital structure of option 2

𝑜𝑟𝑑𝑖𝑛𝑎𝑟𝑦 𝑠ℎ𝑎𝑟𝑒 = 4000 + 2000 = 6000@𝑅𝑠 100

𝑝𝑟𝑒𝑓𝑒𝑟𝑒𝑛𝑐𝑒 𝑠ℎ𝑎𝑟𝑒 = 𝑅𝑠 3,00,000@10% 𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑝𝑒𝑟 𝑦𝑒𝑎𝑟

Loan Rs 8,00,000 loan @10% per year and Rs 5,00,000 loan @12% interest per year

Calculation:

a) 𝑒𝑎𝑟𝑛𝑖𝑛𝑔 𝑏𝑒𝑓𝑜𝑟𝑒 𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑎𝑛𝑑 𝑡𝑎𝑥 (𝐸𝐵𝐼𝑇) = 𝑅𝑠 3,50,000

b) 𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑜𝑛 𝑙𝑜𝑎𝑛 = 10% 𝑜𝑓 8,00,000 + 12% 𝑜𝑓 5,00,000 = 𝑅𝑠 1,40,000
c) 𝑒𝑎𝑟𝑛𝑖𝑛𝑔 𝑎𝑓𝑡𝑒𝑟 𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑏𝑒𝑓𝑜𝑟𝑒 𝑡𝑎𝑥 (𝐸𝐴𝐼𝐵𝑇) = (𝑎 − 𝑏) = 2,10,000
d) 𝑡𝑎𝑥 @30% 𝑜𝑓 𝐸𝐴𝐼𝐵𝑇 = 𝑅𝑠 63,000
e) 𝑒𝑎𝑟𝑛𝑖𝑛𝑔 𝑎𝑓𝑡𝑒𝑟 𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑎𝑛𝑑 𝑡𝑎𝑥 (𝐸𝐴𝐼𝑇)(𝑐 − 𝑑) = 1,47,000
f) 𝑖𝑛𝑡𝑒𝑟𝑠𝑡(𝑑𝑖𝑣𝑖𝑑𝑒𝑛𝑑) 𝑡𝑜 𝑝𝑟𝑒𝑓𝑒𝑟𝑒𝑛𝑐𝑒 𝑠ℎ𝑎𝑟𝑒 ℎ𝑜𝑙𝑑𝑒𝑟𝑠 = 10% 𝑜𝑓 3,00,000 = 𝑅𝑠 30,000
g) 𝑑𝑖𝑣𝑖𝑑𝑒𝑛𝑑𝑠 𝑡𝑜 𝑒𝑞𝑢𝑖𝑡𝑦 𝑠ℎ𝑎𝑟𝑒 ℎ𝑜𝑙𝑑𝑒𝑟𝑠 = 𝑅𝑠1,47,000 − 30,000 = 1,17,000
1,17,000
h) 𝑒𝑎𝑟𝑖𝑛𝑔 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒 (𝐸𝑃𝑆) = 6000
= 𝑅𝑠 19.5

By analysing both options, we can conclude that earning per share (EPS) is Rs 19.5 in option 2 as against
Rs 17.32 in option 1. So, the firm should choose option 2.

Er. Santosh Kr.Shrestha Er. Ishwar Adhikari

Er. Santosh Kr.Shrestha Er. Ishwar Adhikari