Lalit

Shivhare
: Project Planning and Phases

Projects Planning, analysis, Selection,

Financing, Implementation and Review
by Prasanna Chandra
 Need and Importance

 Long-Term Effects
 Irreversibility
 Substantial outlays
 Phases of Capital Budgeting
 Complex Process:
1. Planning
2. Analysis
3. Selection
4. Financing
5. Implementation
6. Review
 Planning phase
 Broad Investment strategy
 Generation of Ideas
 Preliminary screening of project
proposals
 Analysis
 If preliminary screening suggests that project is
viable, a detailed analysis is undertaken
Facets/Aspects of Project Analysis:
a. Marketing: Potential Market and Market
Share
b. Technical: Technical Viability and Choice of
Technology
c. Financial: Risk Vs. Return
d. Economic: Social Benefits and costs
e. Ecological: Environmental damage and
Restoration measures
 Analysis (Contd.)
 Gathering, preparing and summarising
relevant information
 Stream of costs and benefits associated
with the project are identified
 Selection
 Out of the various project proposals, the
project which gives the optimum benefits as
compared to cost is selected.
 To select the project that gives optimum
benefits, appraisal criteria is used:
1. Non-Discounting criteria
2. Discounting criteria
Important Criteria of Selection
1. Non-Discounting Criteria:
a. Payback period
b. Accounting rate of return
2. Discounting Criteria:
a. Net Present Value
b. Internal Rate of Return
c. Benefit Cost Ratio
 Financing
 Once a project is selected, Capital Structure
decision is to be taken to finance the
project
 Capital structure decision comprises of mix
of:
1. Equity: Paid-up capital, Share premium and
retained earnings
2. Debt: Term loans, debentures and working
capital advances
 Capital structure decision
 The mix of equity-debt and the source of
finance is influenced by the following key
business considerations: (FRICT)
1. Flexibility
2. Risk
3. Income
4. Control
5. Taxes
 Implementation
 Setting up of manufacturing facilities:
1. Project and Engineering Designs
2. Negotiations and contracting
3. Construction
4. Training
5. Plant commissioning
 Implementation (Contd.)
 For expeditious implementation at a
reasonable cost:
1. Adequate formulation of the Project
2. Use the principle of Responsibility
Accounting
3. Use of Network Techniques
 Review
 Performance review to be done
periodically – compare actual
performance with projected
performance
 It helps in:
1. Future decision-making
2. Take Corrective action
3. Investors are cautioned
 Feasibility Study
 The first four phases of capital
budgeting – Planning, Analysis,
Selection and Financing constitute the
feasibility study of the project
 Resource Allocation
Framework
 Project management/Capital Budgeting
is basically managing the resource
allocation process
 For optimum resource allocation,
strategic planning is required which
identifies valuable investment
opportunities
 Investment Strategies
 Strategy: The determination of the basic
long-term objectives of an enterprise and the
adoption of courses of action and the
allocation of resources necessary to carry out
these objectives
 It is matching the firm’s strengths and
weaknesses with the opportunities and
threats present in the external environment
 Strategic Planning
 Optimal match between the capabilities of the
business and the opportunities in the
environment
 Cross-Sectional relationships between existing
assets and growth opportunities
 Time-series relationships between current
growth opportunities and future growth
opportunities
 Impact of new investments on the Risk profile
of the business
 Strategy
 Growth:
1. Concentration
2. Vertical Integration: a. Forward and
b. Backward
3. Diversification: a. Concentric
b. Conglomerate
 Strategy (Contd.)
 Stability
 Contraction:
1. Divestiture
2. Liquidation
 Strategy (Contd.)
 Concentration: When a business house
estimates growth in the market size of
its existing product, it expands the
capacity of its product.
 Vertical Integration:

1. Backward: It manufactures raw

materials and components required for
the existing operations
 Strategy (Contd.)
2. Forward: It manufactures products that
uses existing products as input.
 Diversification:

1. Concentric: Business house gets into a

related business to the existing one
2. Conglomerate: Business house gets
into a new business which is unrelated
to its existing business
 Strategy (Contd.)
 Stability: A business is satisfied to
serve the same product market and
has no wish to expand or diversify
 Contraction: 1. Divestiture: Sale of
business unit or part of it
2. Liquidation: When the business is in
continuous loss and there is no chance
of any revival
 Portfolio planning tools
 Corporations can be organised as portfolio
of business units
 They use conglomerate diversification as
their investment strategy
 Such corporations require allocation of
resources across business units
 Portfolio planning tools guide the process of
strategic planning and resource allocation
Portfolio planning tools (Cont.)
 BCG matrix: -
- Developed by Boston Consulting Group
- Businesses in a portfolio are classified
on the basis of :
a. Relative market share
b. Relative market growth rate
 BCG Matrix
The BCG matrix classifies businesses into:
a. Stars: - High market share and a high
growth rate
- They earn high profits and require
additional funds to expand
b. Question marks: - High growth rate but low
market share
- Additional resources are required to improve
market share to convert into stars
 BCG Matrix (Contd.)
c. Cash Cows: - High market share but
low growth rate
- Cash surpluses are available for use

elsewhere
d. Dogs: - Low market share and low
growth rate
- Close down
 BCG Matrix: Conclusion
 Cash Cows generate funds and Dogs
release funds if divested
 Stars and Question Marks require
additional funds
 Hence the funds released should be
allocated to Stars and Question Marks
 General Electric Stoplight
Matrix
It evaluates businesses in terms of:
1. Business Strength and
2. Industry Attractiveness
- Business which are favourably placed justify
high commitment of funds
- Business which are placed unfavourably call
for divestment
- Business which are placed in between call
for modest investment
 Mckinsey matrix
 Two Dimensions:
1. Competitive position and
2. Industry Attractiveness
- Criteria are used and weights are suggested
- Winners justify larger commitment of
resources, losers call for divestments and
Question Mark, Average Business and Profit
Producer call for moderate commitment of
funds
 Criteria and weights
Industry Attractiveness
Criteria Weight
Industry Size 0.10
Industry growth 0.30
Industry Profitability 0.20
Capital Intensity 0.05
Technological Stability 0.10
Competitive Intensity 0.20
Cyclicality 0.05
Criteria and weights
Competitive Position
Criteria Weight
Market Share 0.15
Technological Knowhow 0.25
Product Quality 0.15
After-sales service 0.20
Price Competitiveness 0.05
Low Operating Costs 0.10
Productivity 0.10
 Interface between Strategic
Planning and Capital Budgeting
 Capital Budgeting should be squarely
related to Corporate Strategy
 Generation of Project Ideas
 A good project idea will lead to a successful
project
 The key is right business at the right time
 Identification of good project ideas
requires:
a. Imagination and creativity
b. Awareness about environmental change and
reaction to this change
c. Realistic assessment of what the business
can do
Generation of Ideas (Contd.)
 It involves:
1. New ideas based on invention and
discovery
2. Observe whatever exists, use
combinations and generate ideas
Considerations and Guidelines
for Generation of Ideas
 Stimulate the flow of ideas:
a. SWOT analysis: Should be periodic
b. Clear Articulation and prioritization of
Objectives: This will channelise the efforts
of employees to think imaginatively
c. Fostering a conducive climate: This will
bring out the creativity and entrepreneurial
urge of people
Considerations and Guidelines
(Contd.)
 Monitoring the Environment - Key Aspects
to be studied:
1. Economic Sector
2. Governmental Sector
3. Technological Sector
4. Socio-demographic Sector
5. Competition Sector
6. Supplier Sector
Considerations and Guidelines
(Contd.)
 Corporate Appraisal: Key Aspects to
be considered:
1. Marketing and Distribution
2. Production and Operations
3. Research and Development
4. Corporate Resources and Personnel
5. Finance and Accounting
Considerations and Guidelines
(Contd.)
 Tools for identifying investment
opportunities:
1. Porter Model: Michael Porter - Profit
potential of an Industry depends on the
combined strength of :
a. Threat of new entrants
b. Rivalry among existing firms
c. Pressure from substitute products
d. Bargaining power of buyers
e. Bargaining power of sellers
 Tools
2. Life Cycle Approach: A product has
four stages:
a. Pioneering Stage
b. Rapid Growth Stage
c. Maturity and Stabilisation Stage
d. Decline Stage
 Life Cycle Approach
 Each stage presents investment opportunities
 Investment in the pioneering stage have a
low return but if one survives, has option to
participate in growth stage
 Investment in the growth stage have a high
return
 Investment in the maturity stage have
average return
 Investment in the decline stage has low
returns
 Tools (Contd.)
3. The Experience Curve: - Investments should
be aimed at reducing costs for long-term
survival and profitability
- Curve shows how the cost per unit behaves

with respect to accumulated volume of

production
- Generally the cost per unit declines due to

learning effects, technological improvements

and economies of scale
Considerations and Guidelines
(Contd.)
 Sources of identifying Project Ideas:
1. Analyse the performance of existing Industries
2. Examine their inputs and outputs
3. Review imports and exports
4. Study plan outlays and Government Guidelines
5. Look at the suggestions of Financial Institutions
and Developmental Agencies
6. Investigate Local Materials and Resources
7. Analyse Economic and Social Trends
 Sources of identifying Project
Ideas
8. Study new Technological developments
9. Draw clues from Consumption abroad
10. Explore the possibility of reviving sick units
11. Identify unfulfilled Psychological Needs
12. Attend Trade Fairs
13. Stimulate creativity
14. Chance Factor and luck
 Screening of Project Ideas
 A long list of project ideas have been generated
and so need to select goods ideas and eliminate
bad ones
 Aspects to be looked into:
1. Compatibility with the Promoter
2. Consistency with Governmental Priorities
3. Availability of Inputs
4. Adequacy of the Market
5. Reasonableness of Cost
6. Acceptability of Risk Level
 Screening of Project Ideas
(Contd.)
 Project Rating Index: The screening may be done
on the basis of rating
 Sources of positive NPV: There are six main entry
barriers that result in positive NPV projects:
1. Economies of scale
2. Product differentiation
3. Cost advantage
4. Marketing reach
5. Technological edge
6. Government Policy
 Screening of Project Ideas
(Contd.)
 On being a Entrepreneur: Questions
that an entrepreneur should answer:
1. Are my goals well defined
2. Do I have the right strategy
3. Can I execute the strategy
 Screening of Project Ideas
(Contd.)
 Qualities and Traits of a Successful
Entrepreneur:
1. Willingness to make sacrifices
2. Leadership
3. Decisiveness
4. Confidence in the Project
5. Marketing and Financial Orientation
6. Strong ego
7. Open mindedness
Unit-2: Project Analysis
 Market and Demand Analysis

 Estimate the aggregate demand for the

product/service
 Estimate the share of the market
 Factors to be considered:
1. Patterns of Consumption growth
2. Income and price elasticity of demand
3. Composition of market
4. Nature of Competition
5. Availability of Substitutes
6. Reach of distribution channels, etc.
 Steps
1. Situational analysis & specification of
objectives
2. Collection of secondary information
3. Conduct of market survey
4. Characterisation of the market
5. Demand Forecasting
6. Uncertainities in demand forecasting
7. Market planning
 Sources of Secondary
Information
 A GOI every ten years - Census of India
 National Sample Survey Reports by Cabinet Secretariat
 Plan Reports by the planning commission at the beginning, middle &
end of five year plans
 Annual Statistical Abstract of the Indian Union, Annual survey of
Industries and monthly studies of Production of Selected Industries by
Central Statistical Organisation
 Annual India Year Book by Ministry of Information & Broadcaasting
 Annual Statistical Year Book by United Nations
 Annual Economic Survey by Ministry of Finance
 Annual Guidelines to Industries by Ministry of Industrial Development
 Annual Reports of the Development Wing, Ministry of Commerce &
Industry
 Sources of Secondary
Information (Contd.)
 Annual Bulletin of Statistics of Exports & Imports by Department of
Commerce
 Techno-Economic Surveys by The National Council of Applied Economic
Research
 Industrial Potential Surveys by IDBI & other Financial Institutions
 A ten year Stock Exchange Directory by Bombay Stock Exchange
 Monthly Bulletins of RBI
 Publications of Advertising agencies
 Other Publications like Weekly bulletin of Industrial Licenses, Import
Licenses and Export licenses by GOI; Studies of State Trading
Corporation; Commodity reports by IIFT; Reports of Export Councils
and Commodity Boards; Annual report on currency and financ3
 Industry Specific
 Evaluation of Secondary
Information
 It is available economically & readily
 But it should be examined for:
a. Reliability
b. Accuracy
c. Relevance
 Conduct of Market Survey
 Secondary information needs to be
supplemented with primary information
gathered through a market survey
 The market survey may be:
a. Census Survey: Entire population is
surveyed
b. Sample Survey: A sample of population is
surveyed & inferences about the population
is drawn
 Steps in a Sample Survey
 Define the Target Population
 Select the Sampling Scheme & Size
 Develop the Questionnaire
 Recruit & train the field investigators
 Obtain information
 Scrutinise the information
 Analyse & interpret the information
 Problems in a survey
 Heterogeneity of the Country
 Multiplicity of Languages
 Design of Questionnaire
 Characterisation of Market
 Effective Demand in the Past and Present
 Breakdown of Demand: By
a. Nature of Product
b. Consumer Groups
c. Geographical Division
 Price
 Methods of Distribution and Sales Promotion
 Consumers: Dimensions
i) Demographic and sociological
ii) Attitude
 Supply and Competition
 Government Policy
 Demand Forecasting
 Methods
I Qualitative
a. Jury of Executive Opinion
b. Delphi
II Time Series Projection
a. Trend Projection
b. Exponential Smoothing
c. Moving Average
III Causal
a. Chain ratio
b. Consumption level
c. End use
d. Leading Indicator
e. Econometric
 Qualitative
 Forecast is based on the judgement of experts
a. Jury of Executive Opinion
Solicits opinions of a group of executives on expected future
demand & combining them into an estimate
Advantages
i) Expeditious
ii) A variety of factors are included in the estimate
iii) Appealing to executives
Disadvantages
i) Subject to biases
ii) Not too reliable
 Delphi
 Opinions of a group of experts through mail survey
 Steps
a. A group of experts is sent a questionnaire to express their
views
b. The responses received are summarised without disclosing
the identity & sent back along with a questionnaire to find out
the reasons for the extreme views expressed in the first
round
c. The process is continued for one or more rounds till a
reasonable agreement is reached in view of the experts
Advantages
i) Intelligible
ii) More accurate and less expensive
 Time Series Projection
 Forecast is based on an analysis of the historical time series
a. Trend Projection
 Determines the trend of demand by anlaysing past Demand
 Projects future demand by extrapolating the trend
 Linear relationship is used
 Y = a + bX
Y = Demand
a = intercept =Mean of Y – b(mean of X)
b = slope = Sum of XY – n(mean of X)(mean of Y)
Sum of X square – n(mean of X)square
X = time variable
 Forecast demand by Trend
Projection
Q1. You are required to forecast demand for the year 2007 to 2011 based on the demand data
given below:
Year Demand
1993 10
1994 13
1995 14
1996 17
1997 18
1998 18
1999 19
2000 20
2001 22
2002 23
2003 22
2004 24
2005 24
2006 25
 Exponential Smoothing
 Forecasts are modified as per observed errors
 Ft+1 = Ft +Alpha et

Ft+1 = forecast for the next period

Ft = forecast for the current period
Alpha = smoothing parameter (which lies
between 0 and 1)
Et = error in the forecast for current period =
St – Ft
St = Actual Sales for the current period
Forecast Demand by Exponential
Smoothing
Q2. Given the initial forecast = 29 and smoothing parameter = 0.2
Forecast demand for the given observations:
Period Observed data
1 28.0
2 29.0
3 28.5
4 31.0
5 34.2
6 32.7
7 33.5
8 31.8
9 31.9
10 34.3
11 35.2
 Exponential Smoothing
(Contd.)
 How should the first forecast and the smoothing
parameter be chosen?
 First forecast is the mean of the warm-up sample
 Warm-up sample are observations of the previous
period for which the forecasting exercise has begun
 Smoothing parameter shall be one of the several
values in the range of 0 to 1 which minimises the
MSE(mean sqaured error) in the warm-up period
 MSE = Sum of (St – Ft) sqaure / n
 Moving Average
 The forecast for the next period is equal to the average of the sales for several
preceding periods
Q3. If four years averaging is done, forecast the demand based on the data given
below:
Year Sales
1 28.0
2 29.0
3 28.5
4 31.0
5 34.2
6 32.7
7 33.5
8 31.8
9 31.9
10 34.3
11 35.2
12 36.0
 Causal
 More analytical
 Based on cause-effect relationships
a. Chain Ratio
 Demand is estimated by applying a series of factors
Q4. Forecast the demand for stainless steel blades of XYZ Ltd. in Indore
based on the following information:
 Total population 25 lakhs
 Percentage of adult males 25%
 Proportion of adult male population using shaving blades 90%
 Number of times a person uses shaving blades – every alternate day
 Average number of shavings per stainless steel blade – 3
 Proportion of stainless steel blade market the company could
capture 35%
 Consumption Level
 It estimates demand on the basis of elasticity coefficients
1. Income: It measures the responsiveness of demand to
variations in income
Ei = Q2 – Q1 X I1 +I2
I2 – I1 Q2 + Q1
Ei = income elasticity of demand
Q1= Quantity demanded in the base year
Q2= Quantity demanded in the following year
I1 = income level in the base year
I2 = income level in the following year
Given the elasticity, Q2 = (Q1) (1+ % change in income level x Ei)
 Income Elasticity of Demand
Q4. Q1 = 50, Q2= 55, I1 = 1,000 and I2 = 1,020.
What is the income elasticity of demand?
 The income elasticity of demand & projected income

is used to obtain a demand forecast

Q5. If the present per capita annual demand for paper
is 1 kg & the present per capital annual income is Rs.
18,200. The income elasticity of demand for paper is
2. The projected per capita annual income three
years hence is expected to be 10 per cent higher
than what it is now. Find out the demand for paper
three years hence.
 Price Elasticity of Demand
Price: It measures the responsiveness of demand to
variations in price
Ep = Q2 – Q1 X P1 +P2
P2 – P1 Q2 + Q1
Ep = price elasticity of demand
Q1= Quantity demanded in the base year
Q2= Quantity demanded in the following year
P1 = price per unit in the base year
P2 = price per unit in the following year
Given the elasticity, Q2 = (Q1) (1+ % change in price
level x Ei)
 Price Elasticity
Q6. P1 = Rs. 600, Q1 = 10,000, P2= Rs.
800, Q2 = 9000. What is the price
elasticity of demand?
 The price elasticity of demand &

expected price change is used to obtain

a demand forecast
 End Use
 Also referred to as consumption coefficient
 suitable for estimating the demand for
intermediate products
 Key inputs:
(i) Projected output levels of consuming
industries
(ii) Consumption coefficients: Input required
per unit of output
 Bass Diffusion Model
 Developed by Frank Bass
 Estimates the pattern of sales growth for new

products
 Considers two factors:

p: The coefficient of innovation - likelihood that a

potential customer would adopt the product because
of its innovative features
q: The coefficient of imitation – tendency of a potential
customer to buy the product because many others
have bought it
Nt = pN + (q – p)nt-1 + (q/N) x (nt-1)(nt-1)
 Problem Sum
Q7. A new product has a potential market
size of 10,00,000, p = 0.03 and q =
0.08. Forecast the demand for the first
five years.
 Leading Indicator
 Two indicators
1. Leading: variables which change ahead of other
variables
2. Lagging: The other variables
 Observed changes in leading indicators are used to
predict the changes in lagging variables
 Steps involved:
a. Identify the leading indicators
b. Establish relationship between the leading
indicators & the variable to be forecast
 Econometric Model
 A mathematical representation of economic relationship
 Forecast the future behavior of the economic variables
 Two types of econometric models:
1. Single equation: Assumes that one variable as dependent
(explained variable) is influenced by one or more independent
variables (explanatory variables) For e.g. Demand for a
product is influenced by price and income
2. Simultaneous equation: Two or more equations. For e.g. GNP
= Govt. Purchases + gross investment + Consumption,
another equation is that Investment and consumption is a
linear function of GNP
Econometric Model (Contd.)
 Steps of construction & use of model:
a. Specification: expression of an economic
relationship in a mathematical form
b. Estimation: determination of parameter values (a
and b) & other statistics by least squares method
c. Verification: accepting or rejecting the specification
as a reasonable approximation to the truth on the
basis of the results of estimation
d. Prediction: projection of the value of the explained
variables
 Uncertainties in Demand
Forecasting
 Arises from:
1. Data about past & present market:
a. Lack of standardisation
b. Few Observations
c. Influence of Abnormal factors
2. Methods of forecasting
a. Inability to handle unquantifiable factors
b. Unrealistic assumptions
c. Excessive data requirement
 Uncertainties in Demand
Forecasting
3. Environmental change:
a. Technological
b. Shift in Government policy
c. Developments on the international
scene
d. Discovery of new sources of Raw
Material
e. Vagaries of Monsoon
 Coping with Uncertainties
 Conduct analysis with data based on uniform
& standard definitions
 In considering trends, coefficients &
relationships ignore abnormal observations
 Critically evaluate the assumptions
 Adjust the projections in the light of
unquantifiable influences
 Monitor the environment continuously
 Consider alternative scenarios
 Conduct sensitivity analysis
 Marketing Plan
 Current market situation – examines
a. Market – size, growth, consumer behavior
b. Competition – major competitors, their
objectives, strategies, strengths
c. Distribution – capabilities of competitors,
number of outlets, special schemes to be
offered
d. Macro-environment – effect of social,
political, economic, technological & other
external variables
 Marketing Plan (Contd.)
 Opportunity & issue analysis – SWOT
is conducted & core issues are
identified – Where the product should
be launched & brand name
 Objectives – Should be clear-cut,
specific & achievable – sales, profit &
targets
 Marketing Plan (Contd.)
 Marketing strategy –
a. Target Segment
b. Positioning – placing product in the minds of
customers
c. Product Line – One or more variants of the product
d. Price
e. Distribution network
f. Sales Force
g. Sales Promotion
h. Advertising budget & modes
 Marketing Plan (Contd.)
 Action programme – operationalise the
strategy in the coming period
 Technical Analysis
 Ensure that the project is technically
feasible – all the required inputs are
available
 Facilitate the optimal formulation of the
project – technology, size, location, etc.
 Steps of Technical Analysis
1. Manufacturing Process/Technology
Alternative technologies are available
a. Choice of technology: decision based on following
factors –
i) Plant Capacity
ii) Principal inputs
iii) Investment outlay & production cost
iv) Use by other units
v) Product mix
vi) Latest developments
vii) Ease of absorption
 Steps of Technical Analysis
(Contd.)
b. Appropriateness of Technology
Technology should be suitable to local economic, social &
cultural conditions
2. Technical Arrangements – If vide collaboration, aspects of
agreement:
a. Support provided
b. Process and performance guarantees
c. Price
d. Continuing benefit of Research & Development
e. Period of agreement
f. Restrictions if any
g. Level of equity participation
h. Termination of agreement in case of violations
 3. Material Inputs & Utilities
 Specifying properties & supply programme
 Classified into-
a. Raw materials: Classified into
i) Agricultural products –
- Quality
- Assessment of quantities available, current and potential
i) Mineral products –
- quantum of exploitable deposits
- Location, size & depth of deposits
- Composition of ore, level of impurities & physical, chemical &
other properties
 Material Inputs & Utilities
(Contd.)
i) Livestock and forest products
ii) Marine products
b. Processed industrial materials & components –
properties, requirement, quantity available,
dependability & price
c. Auxiliary materials – chemicals, packaging
materials, paint, varnishes, oils, greases, cleaning
materials
d. Utilities – power, water, steam, fuel, transportation
- Based on location, technology & plant capacity
- requirement, sources, availability, shortages/
bottlenecks, alternatives, cost, investment
 4. Product Mix
 Variations in size and quality satisfy a wide range of
customers
 Expands the market & leads to high profitability
 Planning of production facilities should provide
flexibility in product mix
 Alteration of product mix responds to changes and
enables to survive & grow
 Careful analysis is required for choosing the degree
of flexibility in product mix, since it involves extra
cost
 5. Plant Capacity
 Units that can be manufactured
1. Feasible normal capacity (FNC) –
capacity attainable under normal
working conditions on the basis of
installed capacity, technical conditions,
stoppages, downtime, holidays
2. Installed capacity
 Plant Capacity (Contd.)
 Factors effecting the FNC:
1. Technological requirement – Technology chosen may require a
minimum capacity
2. Input constraints – there may be limit on the availability of inputs
3. Investment cost – it decreases with the increase in plant capacity
C2 = C1(Q2/Q1)raised to alpha
C2 – derived cost for Q2 units of capacity
C1 – known cost for Q1 units of capacity
Alpha – factor reflecting capacity-cost relationship (0.2<Alpha<0.9)
Q8. The known investment cost for 5000 units of capacity is Rs.
10,00,000. What will be the investment cost for 10,000 units of
capacity if the capacity-cost factor is 0.6.
 Plant Capacity (Contd.)
4. Market conditions – Stronger the
market, higher plant capacity is
required
5. Resources – managerial & financial
6. Government policy
 6. Location & Site
 Assessment of demand, size & input
 Location is a broad area
 Site is a specific land
 Choice of location is affected by:
1. Proximity to raw materials & markets – optimal
location is one where the total transportation,
production and distribution cost is minimum
2. Availability of infrastructure
3. Labour Situation – availability, rates, productivity,
industrial relations, unionisation
4. Government policies – based on regional dispersion
 6. Location and Site
5. Other Factors:
a. Climatic conditions
b. General living conditions
c. Proximity to ancillary units
d. Ease in coping with pollution
 Site Selection – evaluated based on
cost of land & site preparation &
development
 7. Machineries & Equipments
 Based on production technology, plant
capacity & type of project
 Steps:
1. Estimate the level of production over time
2. Define the machining & operations
3. Calculate the machine hours of each
operation
4. Select machineries & equipments required
 Machineries & Equipments
(Contd.)
 Types of equipments:
a. Plant/Process
b. Mechanical
c. Electrical
d. Instruments
e. Controls
f. Internal transportation
g. Others
 Machineries & Equipments
(Contd.)
 Spare parts & tools:
a. To be purchased with the original eqipment
b. Required for operational wear & tear
 Constraints in selection:
a. Limited availability of power
b. Transporting a heavy equipment
c. Workers may not be able to operate
d. Import policy may not allow
 Machineries & Equipments
(Contd.)
 Procurement: Factors to be considered in
selecting a supplier:
a. Desired quality
b. Technology required
c. Reputation of supplier
d. Expected delivery schedule
e. Payment terms
f. Performance guarantee
 8. Structure & Civil Works
 Site preparation & development:
a. Grading & leveling
b. Demolition & removal of unwanted structures
c. Relocation of existing pipelines, cables, roads, power lines
d. Connections of utilities
 Buildings & structures:
a. Factory
b. Ancillary – stores, labs, maintenance, utility
c. Administrative
d. Staff welfare
e. Residential
 Structure & Civil Works
(Contd.)
 Outdoor works:
a. Supply of utilities
b. Handling & treatment of emissions
c. Transportation
d. Outdoor lighting
e. Landscaping
f. Enclosure
 9. Environmental Aspects
 Types of effluents generated
 Disposal of effluents
 Secure environmental clearances &
comply with statutory requirements
 10. Project Charts & Layouts
1. General Functional layout – relationship
between equipments, buildings and civil
works
2. Material Flow
3. Production Line
4. Transport
5. Utility Consumption
6. Communication
7. Organisational
 Project Charts & Layouts
(Contd.)
8. Plant: physical layout of the factory
Considerations –
a. Consistency with production technology
b. Smooth flow of goods
c. Utilisation of space
d. Scope for expansion
e. Minimisation of production cost
f. Safety of personnel
 11. Schedule of Project
implementation
 List all possible activities from project planning to
commencement of production
 Sequence of activities
 Time required for activities
 Resources required for activities
 Use bar charts, PERT/CPM analysis
PERT/CPM are network planning techniques which can handle
innumerable activities, complex interdependency relationships,
resource constraints, probabilistic estimates and cost-time
tradeoffs
 Work schedule: - installation & initial operations
- Avoid losses from idle capacity & deterioration of stocks
- Commissioning of plant to be synchronised with the availability
of inputs
 12. Need for considering
Alternatives
There are alternative ways of transferring an
idea into a project. The alternatives may
differ with respect to:
 Nature of Project
 Production Process
 Product quality
 Scale of operations & time phasing
 Location
 Key project inter-linkages
 Financial Estimates &
Projections
 Develop projections for:
1. Profit & Loss A/C
2. Balance Sheet
3. Fund Flow Statement
 Steps for developing projections:
1. Cost of Project:
a. Land & Site Development
b. Building & civil works – cost depends on the kind of
structures
- estimates are based on the plinth area & the
rates for type of structures
 Cost of Project
c. Plant & Machinery – Cost of imported P&M = FOB + shipping +
freight + insurance + import duty + clearing + loading + unloading
+ transportation
- Cost of indigenous P&M = FOR + VAT + octroi + other taxes +
railway freight + transportation
- Cost of stores & spares
- installation charges
- estimates based on latest available quotation adjusted for
escalation
Escalation = latest rate of annual inflation applicable to plant &
machinery X length of delivery period
d. Technical know-how & Engineering fees – if royalty is payable
annually it is an operating expense
e. Expenses on foreign & Indian technicians – travel + boarding +
lodging + salaries + allowances
 Cost of Project (Contd.)
f. Miscellaneous fixed assets – furniture, office
machinery & equipment, tools, vehicles, DG,
transformers, boilers, etc.
g. Preliminary expenses – identifying the
project, market survey, feasibility report,
drafting MOA and AOA, ROC expenses
h. Capital Issue expenses – underwriting,
brokerage, fees to registrar, printing &
postage, advertising, listing fees, stamp
duty
 Cost of Project (Contd.)
i. Pre-operative expenses – expense incurred till commencement
of commercial production
- Directly related to project implementation schedule
- any delay shall increase the expenses
- financial institutions allow 20-25% delay
- are capitalised by apportioning them to fixed assets or
treated as deferred revenue expenditure and w/off over a
period of time
j. Provision for contingencies – to estimate divide the project cost
into
(a) Firm cost – already incurred/ orders placed
(b) Non-firm cost
Provision shall be 5 to 10 % of non-firm cost/ 10% for total
project cost
 Cost of Project (Contd.)
k. Margin money for Working Capital –
Working capital is provided by banks &
creditors. Certain part of it has to come
from long term sources of finance
(Generally 25%)
l. Initial cash losses
 Working Capital Requirement
 It consists of:
a. Raw materials & components
b. Stocks of Work-in-process
c. Stocks of finished goods
d. Debtors
e. Operating expenses
f. Consumable stores
 Working Capital Financing
 Working Capital Advance – obtained in the form of
aggregate permissible bank finance as per the norms
of lender
 As per Tandon Committee Maximum Permissible
Bank Finance = 0.75(Current Assets – Current
Liabilities)
- It means 25% of net working capital must be
financed by long-term sources of finance which is
known as the margin money for working capital
 Trade Credit
 Accruals & provisions
 Long term source of finance