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MODULE I
1.1. INTRODUCTION
More specifically, what is a project? Its a temporary group activity designed to produce a
unique product, service or result. A project is temporary in that it has a defined
beginning and end in time, and therefore defined scope and resources.
And a project is unique in that it is not a routine operation, but a specific set of
operations designed to accomplish a singular goal. So a project team often includes
people who dont usually work together sometimes from different organizations and
across multiple geographies.
The development of software for an improved business process, the construction of a
building or bridge, the relief effort after a natural disaster, the expansion of sales into a
new geographic market all are projects.
Some other examples of a project are:
Organizing a meeting
And all must be expertly managed to deliver the on-time, on-budget results, learning
and integration that organizations need.
Project management, then, is the application of knowledge, skills and techniques to
execute projects effectively and efficiently. Its a strategic competency for organizations,
enabling them to tie project results to business goals and thus, better compete in
their markets.
Project management processes fall into five groups:
Initiating
Planning
Executing
Closing
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1.2.1.
Importance Capital expenditure decisions often represent the most important decisions taken by a
firm. Their importance stems from three inter-related reasons:
Long-Term Effects The consequences of capital expenditure decisions extend far into the
future. The scope of current manufacturing activities of a firm is governed largely by
capital expenditures made in the past. Likewise, current capital expenditure decisions
provide the framework for future activities. Capital investment decisions have an enormous
bearing on the basic character of a firm.
Irreversibility The market for used capital equipment in general is ill-organised. Further, for
some types of capital equipment, custom- made to meet specific requirements, the market
may virtually be non-existent. Once such an equipment is acquired, reversal of decision
may mean scrapping the capital equipment. Thus, a wrong capital investment decision
often cannot be reversed without incurring a loss.
Difficulties While capital expenditure decisions are extremely important, they also pose difficulties
which stem from three principal sources:
Measurement Problems Identifying and measuring the costs and benefits of a capital
expenditure proposal tend to be difficult. This is more so when a capital expenditure has a
bearing on some other activities of the firm (like cutting into the sales of some existing
product) or has some intangible consequences (like improving the morale of workers).
Uncertainty A capital expenditure decision involves costs and benefits that extend far into
the future. It is impossible to predict exactly what will happen in the future. Hence, there is
usually a great deal of uncertainty characterising the costs and benefits of a capital
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expenditure decision.
1.2.2.
Temporal Spread The costs and benefits associated with a capital expenditure decision are
often spread out over a long period of time, usually 10-20 years for industrial projects and
20-50 years for infrastructural projects. Such a temporal spread creates some problems in
estimating discount rates and establishing equivalences.
TYPES OF CAPITAL INVESTMENTS
Capital investments may be classified in different ways. At the simplest level, capital investments
may be classified as physical, monetary, or intangible.
i.
Physical assets are tangible investments like land, building, plant, machinery, vehicles,
and computers.
ii.
Monetary assets are financial claims against some parties. Deposits, bonds, and equity
shares are examples of monetary assets.
iii.
Intangible assets are not in the form of physical assets or financial claims. They
represent outlays on research and development, training, market development, franchises,
and so on that are expected to generate benefits over a period of time.
Capital investments may also be classified as strategic investments and tactical investments.
iv.
A strategic investment is one that has a significant impact on the direction of the firm.
Tata Motors decision to invest in a passenger car project may be regarded as a strategic
investment.
v.
Capital investments are often classified by companies in different categories for planning and
control. While the system of classification may vary from one firm to another, the following
categories are found in most classifications: mandatory investments, replacement investments,
expansion investments, diversification investments, R&D investments, and miscellaneous
investments.
vi.
A mandatory investment is a capital expenditure required to comply with statutory
requirements. Examples of such investments are a pollution control equipment, a fire
fighting equipment, a medical dispensary, and a creche in the factory.
vii.
A replacement investment is meant to replace worn out equipment with new equipment
to reduce operating costs, increase the yield, and improve quality.
viii.
An expansion investment is meant to increase the capacity to cater to a growing demand.
ix.
A diversification investment is aimed at producing new products or services or entering
into new geographical areas.
x.
R&D investments are meant to develop new products and processes which would
sharpen the technological edge of the firm.
xi.
Finally, miscellaneous investments represent a catch-all category that includes items
like interior decoration, recreational facilities, and landscaped gardens.
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Planning
The planning phase of a firms capital budgeting process is concerned with the articulation of its
broad investment strategy and the generation and preliminary screening of project proposals. The
investment strategy of the firm delineates the broad areas or types of investments the firm plans
to undertake. This provides the framework which shapes, guides, and circumscribes the
identification of individual project opportunities.
Once a project proposal is identified, it needs to be examined. To begin with, a preliminary project
analysis is done. A prelude to the full blown feasibility study, this exercise is meant to assess (i)
whether the project is prima facie worthwhile to justify a feasibility study and (ii) what aspects of
the project are critical to its viability and hence warrant an in-depth investigation.
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Analysis
If the preliminary screening suggests that the project is prima facie worthwhile, a detailed analysis
of the marketing, technical, financial, economic, and ecological aspects is undertaken. The
questions and issues raised in such a detailed analysis are described in the following section. The
focus of this phase of capital budgeting is on gathering, preparing, and summarising relevant
information about various project proposals which are being considered for inclusion in the capital
budget. Based on the information developed in this analysis, the stream of costs and benefits
associated with the project can be defined.
Selection
Selection follows, and often overlaps, analysis. It addresses the questionIs the project
worthwhile? A wide range of appraisal criteria have been suggested to judge the worthwhileness
of a project. They are divided into two broad categories, viz., non-discounting criteria and
discounting criteria. The principal non-discounting criteria are the payback period and the
accounting rate of return. The key discounting criteria are the net present value, the internal rate
of return, and the benefit cost ratio. The selection rules associated with these criteria are as
follows:
To apply the various appraisal criteria, suitable cut-off values (hurdle rate, target rate, and cost of
capital) have to be specified. These are essentially a function of the mix of financing and the level
of project risk. While the former can be defined with relative ease, the latter truly tests the ability
of the project evaluator. Indeed, despite a wide range of tools and techniques for risk analysis
(sensitivity analysis, scenario analysis, simulation analysis, decision tree analysis, portfolio theory,
capital asset pricing model, and so on), risk analysis remains the most intractable part of the
project evaluation exercise.
Criterion
Accept
Reject
NPV> 0
NPV< 0
Financing
Once a project is selected, suitable financing arrangements have to be made. The two broad
sources of finance for a project are equity and debt. Equity (referred to as shareholders funds on
balance sheets in India) consists of paid-up capital, share premium, and retained earnings. Debt
(referred to as loan funds on balance sheets in India) consists of term loans, debentures, working
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capital advances and so on.
Flexibility, risk, income, control, and taxes (referred to by the acronym FRICT) are the key
business considerations that influence the capital structure (debt-equity ratio) decision and the
choice of specific instruments of financing.
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Implementation
The implementation phase for business project that involves setting up of industrial facilities that
consists of several stages such as
1.
2.
3.
4.
5.
Translating an investment suggestion into a material is a complex, time- consuming, and risk
burdened task. Delays in implementation that are common, can lead to considerable cost
overruns. For speedy implementation at a rational cost, the below are helpful.
i)
Adequate Formulation of Projects: A major reason for the delay is inadequate formulation of
projects. Put differently, if the necessary homework in terms of preliminary studies and
comprehensive and detailed formulation of the project is not done, many surprises and
shocks are likely to spring on the way. Hence, the need for adequate formulation of the
project cannot be over-emphasised.
ii) Use of the Principle of Responsibility Accounting: Assigning specific responsibilities to project
managers for completing the project within the defined time-frame and cost limits is helpful
in expeditious execution and cost control.
iii) Use of Network Techniques: For project planning and control two basic techniques are
available - PERT (Programme Evaluation Review Technique) and CPM (Critical Path Method).
These techniques have, of late, merged and are being referred to by a common terminology
that is network techniques. With the help of these techniques, monitoring becomes easier.
Review
Once the project is commissioned, the review phase has to be set in motion. Performance review
should be done periodically to compare actual performance with projected performance. A
feedback device, it is useful in several ways: (i) It throws light on how realistic were the
assumptions underlying the project; (ii) It provides a documented log of experience that is highly
valuable in future decision making; (iii) It suggests corrective action to be taken in the light of
actual performance; (iv) It helps in uncovering judgmental biases; (v) It induces a desired caution
among project sponsors.
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4) Team Work: Project is a team work and it normally consists of diverse areas. There will be
personnel specialized in their respective areas and co-ordination among the diverse areas
calls for team work.
5) Complexity: A project is a complex set of activities relating to diverse areas.
6) Risk and uncertainty: Risk and uncertainty go hand in hand with project. A risk-free, it
only means that the element is not apparently visible on the surface and it will be hidden
underneath.
7) Customer specific nature: A project is always customer specific. It is the customer who
decides upon the product to be produced or services to be offered and hence it is the
responsibility of any organization to go for projects/services that are suited to customer
needs.
8) Change: Changes occur throughout the life span of a project as a natural outcome of
many environmental factors. The changes may vary from minor changes, which may have
very little impact on the project, to major changes which may have a big impact or even
may change the very nature of the project.
9) Optimality: A project is always aimed at optimum utilization of resources for the overall
development of the economy.
10)Sub-contracting: A high level of work in a project is done through contractors. The more
the complexity of the project, the more will be the extent of contracting.
11)Unity in diversity: A project is a complex set of thousands of varieties. The varieties are
in terms of technology, equipment and materials, machinery and people, work, culture and
others.
A project plan can be considered to have five key characteristics that have to be managed:
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Risk: defines in advance what may happen to drive the plan off course, and what will be
done to recover the situation.
Balanced Plans
The sad thing about plans is you cannot have everything immediately. Many people plan using
planning software packages, without realising the trade-offs that must be made. They assume
that if they write a plan down, reality will follow their wishes. Nothing is further from the truth.
The point of a plan is to balance:
Observation
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Government sources
Project selection is a careful study of each project idea in detail and choosing one of them for
further consideration and development. A project idea is universal. However, a project must be
implemented in the background of factors such as
Technology
Equipment
Investment
Location
Market
Project Formulation
The process of studying a selected project further with reference to investment decisions is called
project formulation. It considers issues such as relevance and feasibility of the project.
It involves a step-by-step procedure to investigate and develop project further.
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Government or by the private sector. The following are the major forms of international projects.
Setting up of fully owned subsidiaries abroad
Handling of international projects needs more expertise and greater efforts in view of higher risk
proportion and procedural formalities involved.
Based on Project Completion Time
Based on the constraints on project completion time, projects can be classified into two types,
viz., normal projects and crash projects. Normal projects are those for which there is no constraint
on time. Crash projects are those which are to be completed within a stipulated lime, even at the
cost of ending up with a higher project cost. For example, construction of canal lining with the
condition that the work should be completed before the monsoon starts is a crash project.
Based on Ownership
Based on ownership, projects can be classified into private sector projects, public sector projects
and joint sector projects. A private sector project is one in which the ownership is completely in
the hands of the project promoters and investors. Profit maximization is the prime objective of
private sector projects since the investors invest their money in such projects only with the sole
idea of earning better returns.
Public sector projects are those that are owned by the state. The evolution and growth of public
sector enterprises is the natural consequences of the efforts of Governments for undertaking
developments in a country. The growth of public sector enterprises vary from country to country.
In a country that follows only the system of private enterprises (USA, for example) there is hardly
any public sector enterprise except for essential sectors like defense sectors, public utility services
etc. In socialist countries (China, for example) public enterprises dominate the economy and they
have become public property. In countries that follow a system of mixed economy (India, for
example) both private and public sector enterprises exist.
An enterprise is considered as public enterprise when the state or any other national, regional or
local authority holds at least 51% of its capital and the enterprise is under the control of the state.
In India, public sector undertakings can be owned either by the Central Government or by the
State Governments. Government undertakes investment in public sector enterprises due to many
reasons.
Both developing and under-developed countries need a planned economy for their
sustained growth. The Government announces industrial and trade policies in tune with its
plans to direct the growth of the economy in the desired direction. It becomes imperative
for the Government to invest in growth sectors.
Private sector in developing and under-developed countries are not willing to take up
investments in many planned sectors (sectors that the Government considers as thrust
areas for the development of the economy) either due to huge investments required or
due to unattractive returns from the investments in such projects. Hence it becomes the
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responsibility of the Government to invest and nurture industries in such planned sectors.
Investment in strategic sectors (defense, space research, atomic research etc.) cannot be
given to the private sector for obvious reasons. Also, public utility services sectors can also
be not left fully to the private sector since the private sector by nature is oriented only
towards profit maximization and not in welfare maximization.
The natural resources of a country are the properties of the Government. The natural
resources can be exploited only by the public sector enterprises since the investment
required is huge and the ownership of the resources rests with the Government,
(example: mining, construction of dams for irrigation purposes, hydro power plants.)
Joint sector projects are those in which the ownership is shared by the Government and by private
entrepreneurs. The main consideration for the Governments investment in joint sector projects is
to make use of the managerial talents, entrepreneurial capabilities and marketing skills of the
private entrepreneurs. Joint sector offers hope to the private entrepreneurs since the Government
shares the investment required for the project.
Based on Size
Projects can be classified based on the size into three categories, viz. small projects, medium
sized projects and large projects. The size is normally expressed in terms of the amount of
investment required. The investment limit for the different categories of projects are announced
by the Government and this undergoes periodical changes keeping in view the inflation, the
decision to offer certain incentives to projects categorized as small scale projects etc. As per the
directives of the Govt. of India, projects with investment on plant and machinery up to Rs. 1 crore
are categorized as small scale projects while those with investment in plant and machinery above
Rs. 100 crores are categorized as Large scale projects. Projects with investment limit between
these two categories are Medium scale projects.
Based on Need
Projects can be classified under the following groups, based on the need for project.
1. New project.
2. Balancing project.
3. Expansion project.
4. Modernization project.
5. Replacement project.
6. Diversification project.
7. Backward integration project.
8. Forward integration project.
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Hard Elements
Soft Elements
Strategy
Shared Values
Structure
Skills
Systems
Style
Staff
"Hard" elements are easier to define or identify and management can directly influence
them: These are strategy statements; organization charts and reporting lines; and
formal processes and IT systems.
"Soft" elements, on the other hand, can be more difficult to describe, and are less
tangible and more influenced by culture. However, these soft elements are as important
as the hard elements if the organization is going to be successful.
The way the model is presented in the figure below depicts the interdependency of the
elements and indicates how a change in one affects all the others.
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Strategy: the plan devised to maintain and build competitive advantage over
the competition.
Structure: the way the organization is structured and who reports to whom.
Systems: the daily activities and procedures that staff members engage in to
get the job done.
Shared Values: called "superordinate goals" when the model was first
developed, these are the core values of the company that are evidenced in the
corporate culture and the general work ethic.
Skills: the actual skills and competencies of the employees working for the
company.
1.8.1.
7 S Work Sheet
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1.9.
Market analysis
Technical analysis
Financial analysis
Economic analysis
Ecological analysis
Market Analysis:
Market analysis is concerned primarily with two questions:
What would be the aggregate demand for the proposed product/service in the
future?
To answer the above questions, the market analyst requires a wide variety of information
and appropriate forecasting methods. The kinds of information required are:
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Structure of competition
Cost structure
Elasticity of demand
Consumer
requirements
behaviour,
intentions,
motivations,
attitudes,
preferences,
and
Technical Analysis:
Analysis of the technical and engineering aspects of a project needs to be done
continually when a project is formulated. Technical analysis seeks to determine whether
the prerequisites for the successful commissioning of the project have been considered
and reasonably good choices have been made with respect to location, size, process, etc.
The important questions raised in technical analysis are:
Whether the preliminary tests and studies have been done or provided for?
Whether the availability of raw materials, power, and other inputs has been
established?
Whether the proposed layout of the site, buildings, and plant is sound?
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Means of financing
Cost of capital
Projected profitability
Break-even point
Level of risk
Economic Analysis:
Economic analysis, also referred to as social cost benefit analysis, is concerned with
judging a project from the larger social point of view. In such an evaluation the focus is
on the social costs and benefits of a project which may often be different from its
monetary costs and benefits. The questions sought to be answered in social cost benefit
analysis are:
What are the direct economic benefits and costs of the project measured in terms
of shadow (efficiency) prices and not in terms of market prices?
What would be the impact of the project on the distribution of income in the
society?
What would be the impact of the project on the level of savings and investment in
the society?
What would be the contribution of the project towards the fulfillment of certain
merit wants like self-sufficiency, employment, and social order?
Ecological Analysis:
In recent years, environmental concerns have assumed a great deal of significance
and rightly so. Ecological analysis should be done particularly for major projects which
have significant ecological implications (like power plants and irrigation schemes) and
environment-polluting industries (like bulk drugs, chemicals, and leather processing).
The key questions raised in ecological analysis are:
What is the cost of restoration measures required to ensure that the damage to
the environment is contained within acceptable limits?
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The feasibility study is concerned with the first four phases of capital budgeting, viz.,
planning, analysis, selection (evaluation), and financing, and involves market, technical,
financial, economic, and ecological analysis. The schematic diagram of the feasibility
study is shown below
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market, where the supply of goods meets current market demand. Declining stages
indicate lagging consumer demand for the goods or services supplied by businesses.
Product Niche
Once markets and business cycles are reviewed, companies will develop a product that
meets a specific niche in the market. Products must be differentiated from others in the
market so they meet a specific need of consumer demand, creating higher demand for
their product or service. Many companies will conduct tests in sample markets to
determine which of their potential product styles is most preferred by consumers.
Companies will also develop their goods so that competitors cannot easily duplicate their
product.
Growth Potential
While every market has an initial level of consumer demand, specialized products or
goods can create a sense of usefulness, which will increase demand. Examples of
specialized products are iPods or iPhones, which entered the personal electronics market
and increased demand through their perceived usefulness by consumers. This type of
demand quickly increases the demand for current markets, allowing companies to
increase profits through new consumer demand.
Competition
An important factor of market analysis is determining the number of competitors and
their current market share. Markets in the emerging stage of the business cycle tend to
have fewer competitors, meaning a higher profit margin may be earned by companies.
Once a market becomes saturated with competing companies and products, fewer profits
are achieved and companies will begin to lose money. As markets enter the declining
business cycle, companies will conduct a new market analysis to find more profitable
markets.
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Collection of secondary information
Information may be obtained from secondary and primary sources. Secondary
information is information that has been gathered in some other context and is already
available. Primary information on the other hand represents information that is collected
for the first time to meet the specific purpose on hand secondary information provides
the base and starting point market and demand analysis.
General sources of secondary information: The important sources of secondary
information useful market and demand analysis in the country are mentioned below:
1. National Census
2. National sample survey reports
3. Plan reports
4. statistical abstract of national union
5. Statistical year book
6. Economic survey
7. Guidelines to industries
8. Annual survey of industries
9. Annual reports of the Department of commerce and industry.
10. The exchange directory
11. Monthly bulletin of reserve bank.
12. Publications of advertising agencies
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10. What was the degree of sampling bias and non-response in the information
gathered?
11. What was the degree of misrepresentation by respondents?
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5. Consumers
6. Supply of competition
7. Government Policy
Demand forecasting
After gathering information about various aspects of the market and demand from
primary and secondary sources. An attempt may be made to estimate future demand.
These may classified in three categories as shown
1. Qualitative Methods
2. Time series projection Methods
3. Causal Methods
Description
Jury of executive
opinion
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combines the results of statistical models.
Sales force composite Each salesperson (for example for a territorial coverage)
is asked to project their sales. Since the salesperson is
the one closest to the marketplace, he has the capacity to
know what the customer wants. These projections are
then combined at the municipal, provincial and regional
levels.
Delphi method
Consumer market
survey
Nave Approach
Description
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Time Series
Forecasting
Method
Moving
Averages (MA)
Description
MA is a series of arithmetic means and is used if little or no trend is
present in the data; provides an overall impression of data over time
A simple moving average uses average demand for a fixed
sequence of periods and is good for stable demand with no
pronounced behavioral patterns.
Equation:
F 4 = [D 1 + D2 + D3] / 4
F forecast, D Demand, No. Period
A weighted moving average adjusts the moving average method
to reflect fluctuations more closely by assigning weights to the most
recent data, meaning, that the older data is usually less important.
The weights are based on intuition and lie between 0 and 1 for a
total of 1.0
Equation:
WMA 4 = (W) (D3) + (W) (D2) + (W) (D1)
WMA Weighted moving average, W Weight, D Demand, No.
Period
Exponential
Smoothing
Trend
Projection
Method
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Uncertainties in demand forecasting
Demand forecasts are subject to error and uncertainty which from three principal source.
1. Data about past and present market. The analysis of past and present markets,
which serve as the springboard for the projection exercise, may be vitiated by the
following inadequacies of data:
o
demand
forecasting
on
are
the
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o
Market planning
A marketing plan usually has the following components
1. Current marketing situation
o
Who are your customer groups? What are their needs and requirements?
How large and diverse are they?
Strengths
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o
Weaknesses
Opportunities
Threats
Objectives should meet certain criteria e.g. financial, and marketing which
will be customer focused.
Do you want to change your organisation profile and will you need to
rebrand your organisation?
Will you change the way you promote and advertise yourself?
Will there be any changes in how you reach your customer groupings?
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1.10.2.
TECHNICAL ANALYSIS
Analysis of technical and engineering aspects is done continually when a project is being
examined and formulated. Other types of analyses are dependent and closely
intertwined with technical analysis. Technical analysis is concerned primarily with:
Materials and inputs
An important aspect of technical appraisal is concerned with defining the materials and
inputs required, specifying their properties in some detail, and setting up their supply
programme. There is an intimate relationship between the study of materials and inputs
and other aspects of project formulation, particularly those concerned with location,
technology, and equipment
Materials and inputs may be classified into four broad categories: (i) raw materials, (ii)
processed industrial materials and components, (iii) auxiliary materials and factory
supplies, and (iv) utilities.
(i) Raw materials Raw materials (processed and / or semi- processed) may be
classified into four types: (i) agricultural products, (ii) mineral products, (iii)
livestock and forest products, and (iv) marine products.
(ii)Processed industrial materials and components Processed industrial
materials and components (base metals, semi-processed materials, manufactured
parts, components, and sub-assembly represent an important input for a number
of industries. In studying them the following questions need to be answered: In
the case of industrial materials, what are their properties? What is the total
requirement of the project? What quantity would be available from domestic
source? What quantity would be available from foreign sources? How dependable
are the supplies? What has been the past trend in prices? What is the likely future
behaviour of prices?
(iii)
Auxiliary materials and factory supplies In addition to the basic raw
materials and processed industrial materials and components, a manufacturing
project requires various auxiliary materials and factory supplies, like chemicals,
additives, packaging materials, paints, varnishes, oils, grease, cleaning materials,
etc. The requirements of such auxiliary materials and supplies should be taken
into account in the feasibility study.
(iv)
Utilities A broad assessment of utilizes (power, water, steam, fuel, etc.)
may be made at the time of input study though a detailed assessment can be
made only after formulating the project with respect to location, technology, and
plant selection. Since the successful operation of a project critically depends on
adequate availability of utilities the following points should be raised while
conducting the input study: What quantities are required? What are the sources
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of supply? What would be the potential availability? What are the likely
shortages/bottlenecks? What measures may be taken to augment supplies.
Production technology
For manufacturing a product/service often two or more alternative
technologies are available. For example:
Steel can be made either by the Bessemer process or the open hearth process.
Cement can be made either by the dry process or the wet process.
Soda can be made by the electrolysis method or the chemical method.
Paper, using bagasse as the raw material, can be manufactured by the kraft
process or the soda process.
Vinyl chloride can be manufactured by using one of the following reactions:
acetylene on hydrochloric acid or ethylene or chlorine.
Choice of technology
The choice of technology is influenced by a variety of considerations:
(i) Principal inputs The choice of technology depends on the principal inputs
available for the project. In some cases, the raw materials available influences the
technology chosen. For example, the quality of limestones determines whether
the wet or dry process should be used for a cement plant. It may be emphasized
that a technology based on indigenous inputs may be preferable to one based on
imported inputs because of uncertainties characterizing imports, particularly in a
country like India.
(ii)Investment outlay and production cost The effect of alternative
technologies of investment outlay and production cost over a period of time
should be carefully assessed.
(iii)
Use by other units The technology adopted must be proven by
successful use by other units, preferably in India.
(iv)
Product mix The technology chosen must be judged in terms of the
total product-mix generated by it, including saleable by-products.
(v)Latest developments The technology adopted must be based on latest
development in order to ensure that the likelihood of technological obsolescence
in the near future, at least, is minimized.
(vi)
Ease of absorption The ease with which a particular technology can be
absorbed can influence the choice of technology. Sometimes a high-level
technology may be beyond the absorptive capacity of a developing country which
may lack trained personnel to handle that technology.
Product Mix
The choice of product mix is guided primarily by market requirements. In the production
of most of the items variations in size and quality are aimed the production of most of
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the items, variations in size and quality are aimed at satisfying a broad range of
customers. For example, production of shoes to different customers. It may be noted
that sometimes slight variations in quality can enable a company to expand its market
and enjoy higher profitability. For example, a toilet soap manufacturing unit may by
minor variation in raw material, packaging, and sales promotion offer a high profit
margin soap to consumers in upper-income brackets.
While planning the production facilities of the firm, some flexibility with respect to the
product mix must be sought. Such flexibility enables the firm to alter its product mix in
response to changing market conditions and enhances the power of the firm to survive
and grow under different situations. The degree of flexibility chosen may be based on a
careful analysis of the additional investment requirements for different degrees of
flexibility.
Plant capacity
Plant capacity (also referred to as production as capacity) refers to the volume or
number of units that can be manufactured during a given period. Several factors have a
bearing on the capacity decision.
(i) Technological requirement For many industrial projects, particularly in process
type industries, there is a certain minimum economic size determined by the
technological factor. For example, a cement plant should have a capacity of at least 300
tonnes per day in order to use the rotary kiln method; otherwise, it has to employ the
vertical shaft method which is suitable for lower capacity.
(ii)Input constraints In a developing country like India, there may be constraints
on the availability of certain inputs. Power supply may be limited; basic raw
materials may be scarce; foreign exchange available for imports may be
inadequate. Constraints of these kinds should be borne in mind while choosing
the plant capacity.
(iii)
Investment cost When serious input constraints do not obtain, the
relationship between capacity and investment cost is an important consideration.
Typically, the investment cost per unit of capacity decreases as the plant capacity
increases. This relationship may be expressed as follows:
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PROJECT MANAGEMENT
than the initial level of demand- further additions to capacity may be affected with the
growth of market.
(v)Resources of the firm The resources, both managerial and financial, available
to a firm define a limit on its capacity decision. Obviously, a firm cannot choose a
scale of operations beyond its financial resources and managerial capability.
(vi)
Governmental policy The capacity level may be constrained by
governmental policy. Given the level of additional capacity to be created in an
industry, within the licensing framework of the government the government may
decide to distribute the additional capacity among several firms.
Location and site
The choice of location and site follows an assessment of demand, size, and input
requirement. Though often used synonymously, the terms 'location' and 'site' should be
distinguished. Location refers to a fairly broad area like a city, an industrial zone, or a
coastal area; site refers to a specific piece of land where the project would be set up.
The choice of location is influenced by a variety of considerations: proximity to raw
materials and markets, availability of infrastructure, governmental policies, and other
factors.
(i) Proximity to raw materials and markets An important consideration for
location is the proximity to sources of raw materials and nearness to the market
for final products. In terms of a basic locational model, the optimal location is one
where the total cost (raw material transportation cost plus production cost plus
distribution cost for final product) is minimized. This generally implies that: (i) a
resource-based project like a cement plant or a steel mill should be located close
the source of basic material (for example, limestone in the case of a cement plant
and iron-ore in the case of a steel plant); (ii) a project based on imported
material may be located near a port; and (iii) a project manufacturing a
perishable product should be close to the center of consumption.
However, for many industrial products proximity to the source of raw material or the
center of consumption may not be very important. Petro-chemical units or refineries, for
example, may be located close to the source of raw material, or close to the center of
consumption, or at some intermediate point.
(ii) Availability of infrastructure
Availability of power,
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reqired. The availability, reliability and cost of transportation for various alternative
locations should be assessed.
Given the plant capacity and the type of technology, the water requirement for the
project can be assessed. Once the required quantity is estimated, the amount to be
drawn from the public utility system and the amount to be provided by the project from
surface or sub-surface sources may be determined. For doing this the following factors
may be examined: relative costs, relative dependabilities, and relative qualities.
In addition to power, transport, and water, the project should have adequate
communication facilities like telephone and fax etc.
(iii)
Governmental policies Governmental policies have a bearing on
location. In the case of public sector projects, location is directly decided by the
government. It may be based on a wider policy for regional dispersion of
industries.
In the case of private sector projects, location is influenced by certain governmental
restrictions and inducements. The government may prohibit the setting up of industrial
projects in certain areas which suffer from urban congestion. More positively, the
government offers inducements for establishing industries in backward areas. These
inducements consist of outright subsidies, concessional finance, tax relief, and other
benefits.
(iv)
Other factors Several other factors have to be assessed before
reaching a location decision: ease in coping with environmental pollution, labour
situation, climatic conditions, and general living conditions.
A project may cause environmental pollution in various ways: it may throw gaseous
emission; it may produce liquid and solid discharges; it may cause noise, heat, and
vibrations. The location study should analyse the costs of mitigating environmental
pollution to tolerable levels at alternative locations.
The labour situation at alternative locations may be assessed in terms of: (i) the
availability of labour, skilled, semi-skilled, and unskilled; (ii) the past trends in labour
rates, the prevailing labour rates, and the projected labour rates; and (iii) the state of
industrial relations judged in terms of the frequency and severity of strikes and lockouts
and the attitudes of labour and management.
The climatic conditions (like temperature, humidity, wind, sunshine, rainfall, snowfall,
dust and fumes, flooding, and earthquakes) have an important influence on location.
They have a bearing on cost as they determine the extent of air-conditioning, dehumidification, refrigeration, special drainage, etc., required for the project.
General living conditions, judged in terms of cost of living, housing situation, and
facilities for education, recreation, transport, and medical care, need to be assessed at
alternative locations.
Machinery and equipment
The requirement of machinery and equipment is dependent on production technology
and plant capacity. It is also influenced by the type of project. For a process-oriented
industry, like a petrochemical unit, machinery and equipment required should be such
that the various stages have to be matched well. The choice of machinery and
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PROJECT MANAGEMENT
equipment for a manufacturing industry is somewhat wider as various machines can
perform the same function with varying degrees of accuracy. For example, the
configuration of machines required for the manufacture of refrigerators could take
various forms. To determine the kinds of machinery and equipment requirement for a
manufacturing industry, the following procedure may be followed: (i) Estimate the likely
levels of production over time. (ii) Define the various machining and other operations.
(iii) Calculate the machine hours required for each type of operation. (iv) Select
machinery and equipment required for each function.
The equipment required for the project may be classified into the following types: (i)
plant (process) equipment, (ii) mechanical equipment, (iii) electrical equipment, (iv)
instruments, (v) controls, (vi) internal transportation system, and (vii) other machinery
and equipment.
In addition to the machinery and equipment, a list should be prepared of spare parts and
tools required. This may be divided into: (i) spare parts and tools to be purchased with
original equipment, and (ii) spare parts and tools required for operational wear and tear.
Constraints in selecting machinery and equipment In selecting the machinery and
equipment, certain constraints should be borne in mind:
(i) there may be a limited availability of power to set up an electricity intensive plant
like, for example, a large electric furnace; (ii) there may be difficulty in
transporting a heavy equipment to a remote location; (iii) workers may not be
able to operate, at least in the initial periods, certain sophisticated equipment
such as numerically controlled machines; (iv) the import policy of the government
may preclude the import of certain types of machinery and equipment.
Structures and civil works
Structures and civil works may be divided into three categories: (i) site preparation and
development, (ii) buildings and structures, and (iii) outdoor works.
(i) Site preparation and development This covers the following: (i) grading and
leveling of the site, (ii) demolition and removal of existing structures, (iii)
relocation of existing pipelines cables, roads, powerlines, etc., (iv) reclamation of
swamps, draining and removal of standing water, (v) connections for the following
utilities from the site to the public network: electric power (high tension and low
tension), water (use water and drinking water), communications (telephone, fax,
etc.), roads, railway sidings, and (vi) other site preparation and developmental
work.
(ii)Buildings Buildings and structures may be divided into: (i) factory or process
buildings; (ii) ancillary buildings required for stores, warehouses, laboratories, utility
supply centers, maintenance services, and others; (iii) administrative buildings; (iv) staff
welfare buildings, cafetaria, and medical service buildings; and (v) residential buildings.
(iii)
Outdoor works Outdoor works cover (i) supply and distribution of
utilities (water, electric power, communication, steam and gas); (ii) handling and
treatment of emissions, wastages, and effluents; (iii) transportation and traffic
arrangements (roads, railway tracks, paths, parking areas, sheds, garages, traffic
signals, etc.): (iv) outdoor lighting; (v) landscaping; and (vi) enclosure and
supervision (boundary wall, fencing, barriers, gates, doors, security posts, etc.).
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Project charts and layouts
Once data is available on the principal dimension of the project market size, plant
capacity, required technology, equipment and civil works, conditions obtaining at plant
site, and supply of inputs to the project project charts and layouts may be prepared.
These define the scope of the project and provide the basis for detailed project
engineering and estimation of investment and production costs.
Work Schedule
The work schedule, as its name suggests, reflects the plan of work concerning
installation as well as initial operation. The purpose of the work schedule is:
To anticipate problems likely to arise during the installation phase and suggest
possible means for coping with them.
To establish the phasing of investments taking into account availability of
finances.
To develop a plant of operations covering the initial period (the running in period).
Often, it is found that the required inputs like raw material and power are not available
in adequate quantity when the plant is ready for commissioning, or the plant is not ready
when the raw material arrives.
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stockholders and investment analysis. The internal analysis is performed by various
departments of a firm.
Significance of financial analysis
Financial analysis primarily deals with the interpretation of the data incorporated in the
proforma financial statements of a project and the presentation of the data in a form in
which it can be utilized for a comparative appraisal of the projects. It is, in effect,
concerned with the development of the financial profile of the project. Its purpose is to
find out whether the project is attractive enough to secure funds needed for its various
constituent activities and once having secured the funds, whether the project will be able
to generate enough economic values to achieve the objectives for which it is sought to
be implemented. It deals not only with the financial aspects of a project but also with its
operational aspects. As such, it is necessary to undertake such an analysis not only in
the case of industrial projects but also in the case of non-industrial projects.
Analysis of financial statements has become very significant due to the widespread
interest of various parties in the financial results of a company. In recent years, the
ownership of capital of most public companies has become broad-based. A number of
parties and bodies, including creditors, potential suppliers, debenture-holders, credit
institutions like banks, industrial finance corporations, potential investors, employees,
trade unions, important customers, economists, investment analysts, taxation authorities
and government have a stake in the financial results of a company. Various people look
at the financial statements from various angles. A number of techniques have been
developed to undertake analysis of financial statements in order to reach conclusions
about the financial health, profitability and efficiency of an enterprise and also to
compare an enterprise with other similar undertakings. The technique of ratio analysis is
the most important tool of financial analysis. It helps in comparing the performance of
various companies and judge their financial soundness.
Utility of financial and accounting statements
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PROJECT MANAGEMENT
Financial statements play a vital role in the internal financial control of an enterprise.
These should, therefore, the properly constructed, analysed and interpreted by
executives, bankers, creditors and investors.
The entire future of a company hinges on the manager's ability to decide relevant
financial data with a view to planning profit ability moves. Learning to read financial
statements is the first essential element in any businessman's attempt to acquire
financial management skills. The change in the elitism of stock ownership to broad public
ownership has necessitated a concomitant change in the entire process of reporting
corporate financial results. The role of management in the matter of preparation of
financial statements is to add understanding to these statements, the fairness of which is
to be viewed through the eye of the user, while that of the accountant is to close the
communication gap and of the auditor to add credibility to them. For evolving a good
economic information system, accounting innovations are of great economic information
system. Without these, communication with the financial community would be difficult,
the interest of present and future potential investors would not be served, the ability of
the company to raise additional capital would be impaired and the government's
regulatory measures and policies would not serve the best interest of society. Though a
financial statement reveals less than it conceals, it provides the indicators of the
enterprise's performance during the year.
Financial analysis seeks to spotlight the significant facts and relationships concerning
managerial performance, viz., corporate efficiency, financial strengths and weaknesses
and creditworthiness of the enterprise.
Social cost benefit analysis (SCBA) is a methodology for evaluating project from social
point of view. It is also referred as economic analysis and is developed for evaluating
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investment project from the point of view of the society. In recent years particularly in
the developing countries where GOVT is playing significant role in economic development
(SCBA) is playing a very important role. It is concerned with tactical decision making
within the framework of broad strategic choice defined by planning at the macro level.
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PROJECT MANAGEMENT
assumed that a rupee of benefit saved is more valuable than a rupee of benefit
consumed. Thus a higher concern of society for saving and investment is duly
reflected in SCBA where higher valuation is put on saving than on consumption.
Concern for redistribution -: while doing monetary cost and benefit
analysis a private firm is least concerned about as to how its benefits are being
distributed among various groups of the society, but while doing SCBA this factor is
kept in mind because it is assumed that a rupee of benefit going to the poor section
is considered more valuable than a rupee of benefit going to an affluent section.
Merit wants -: while merit wants are not relevant from the private point
of view, they are important from the social point of view. E.g. GOVT may prefer to
promote an adult education programme even though they are of no benefit to the
consumers in market, but from the point of view of the society they are important.
APPROACHES to SCBA
1. UNIDO Approach
2. L & M Approach
3. Approach Adopted By Financial Institutions
A. UNIDO Approach -: the UNIDO approach was first articulated in the guidelines
of project evaluation. It involves five stages :
Adjustment for the impact of project on merit goods and demerit goods whose
social value differ from their economic values.
i.
Cost of production
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with a project, which are supported by long term funds. It is the sum total of following:
Land and site development
Building and civil work
Plant and machinery
Technical know-how and engineering fees
Expenses on foreign technicians abroad
Miscellaneous fixed asset
Preliminary and capital issue expenses
Pre-operative expenses
Provisions of contingencies
Margin money of working capital
Initial cash losses
ility projection is the forecast of sales revenues. In estimating sales it is reasonable to assume that
capacity utilisation will be somewhat low in the first year and rise thereafter
gradually to reach the maximum level in the third and fourth year of operation.
Material cost
Labour cost
rking capital requirement and planning for its financing, the following points must be borne in mind -:
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The built of current assets till the rated level of capacity utilisation is
reached.
The maximum permissible bank finance.
Margin requirement against various current assets.
e following lines :
Cost of production
Expected sales
Gross profit
Other incomes
PAT
Dividend
Retained profits
e firm and its net impact on the cash balances of the firm.
accounts, reflects the financial condition of the firm.
ii.
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PROJECT MANAGEMENT
prices. Shadow price is also known as hidden price, a price that is hidden under
monetary cost and benefits.
For a traded good the shadow price is the border price translated in the domestic currency at market
exchange rate. The shadow price in case of non-tradable good is consumer
willingness to pay or cost of production depending on the impact of the project on
the rest of the economy.
ersion of non- traded input from the producer or addition of non-traded input, taxes should be included.
If a project augment domestic production by other producers, taxes should be
excluded and for fully traded goods taxes should be ignored.
s in demand or supply affect just the level of import or export. For a good being tradable the following
condition should be met-:
If, additional demand exist inland, the imported goods even after taking
into account the cost of transport from port to the point of inland demand
should be less than the marginal cost of local production.
The imported input cost should be less than the domestic marginal cost of
purchase.
llingness to pay or cost of production, depending on the impact of project on the rest of the economy.
msoever they may accrue external effects should also be taken into account. The valuation of external
effects is rather difficult because they are often intangible in nature and there is no
market price, which can be used as a starting point.
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Labour inputs -: the principle of shadow pricing may be applied to labour as well,
though labour is considered to be services. When a project takes away labour
from other employment, the shadow pricing of labour is equal to what other
user of labour are willing to pay.
The shadow prices associated with inducing additional production of workers
consist of the marginal product of labour in previous employment plus certain
other costs.
The social cost of associated with import of foreign labour is the wage they
command. However, a premium should added on account of foreign exchange
remitted abroad by these workers from their savings.
Capital input -: the shadow pricing in case of capital investment involves -:
What is the value of physical assets?
What is the opportunity cost of capital?
The value of physical assets is determined the way values of other resources are
calculated.
The opportunity cost of capital depends on how the capital required for the project is
generated. To the extent that it comes from additional savings its opportunity cost is
measured by the consumption rate of interest.
To the extent that it comes from the denial of capital from the alternative project, its
opportunity cost is the rate of return that would be earned from those alternative
projects. This is also called as investment rate of interest.
Foreign exchange -: the UNIDO method uses domestic currency as the numeraire. So
the foreign exchange impact of the project must be identified and valued. The UNIDO
method determines the shadow price of foreign exchange on the basis of marginal social
value as revealed by the consumer willingness to pay for the goods that are allowed to
be imported at the margin.
iii.
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Groups
owing.
Project
Government
Workers
Consumers
External sectors
Measure of gain and loss -: the gain or loss to an individual group within the
society as a result of the project.
In case of physical resources is the difference between the shadow price and the
market price of each input or output.
In case of financial transaction it is the difference between the price paid and
value received.
iv.
Given the income distribution impact of the project what would be the
effect on savings which is equal to-:
What is the value of such savings to the society -: The value of a rupee of
saving is the present value of additional consumption stream produced
when that rupee of saving is invested in the margin.
at the rate of ar forever. Its present value when discounted at the social discount rate k is:
--
1- (1+ar)/(1+k)
_________
k ar
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PROJECT MANAGEMENT
where
v.
Adjustment for merit and demerit goods -: merit good is one for which the
social value exceeds the economic value. For e.g. a country may place a higher
social value than economic value on production of oil because it reduce
dependence on foreign supplies. In case of demerit good the social value is less
than the economic value. For e.g. alcoholic products.
The method of adjusting for the difference between social value and economic
value is as follow -:
Multiply the economic value with the adjustment factor to obtain the
adjustment
The stream of social costs and benefits is obtained after the five steps described above.
The discount rate at which the present value of social costs=social benefits, is called as
social rate of return (SRR). SRR is then compared with the required rate of return. The
SRR of a project forgone may be taken as the desired rate of return. In absence of the
opportunity return, the consumption rate of interest can be taken as the cut-off rate.
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The UNIDO approach measures cost and benefits in term of domestic rupees
price whereas the L-M approach measures cost and benefit in terms of international
prices.
SHADOW PRICING
Traded goods and services -: the shadow prices of traded goods and
services are the border price. If a good is exported its shadow price is the FOB price
and if a good is imported its border price is the CIF price. If foreign demand is not
perfectly elastic the marginal export revenue is substituted for the FOB and if foreign
supply is not perfectly elastic, the marginal import cost is substituted for CIF prices.
Non traded goods and services : accounting prices for non-traded good are
defined in terms of marginal social cost and benefit. The marginal social benefit is the
value of an extra unit of good from social point of view and the marginal social cost
of a good is the value in terms of accounting prices of the resources required to
produce an extra unit of the good. To determine the accounting price of a non traded
input the following formula is to be used -:
Labour -: the L-M approach suggest the following formula for calculating the
shadow wage rate-:
SWR = c 1/s (c-m)
Where SWR = shadow wage rate
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PROJECT MANAGEMENT
The all India term leading financial institutions---IDBI, IFCI, & ICICI-- scrutinise projects
from larger social point of view. ICICI was perhaps the first financial institution to
introduce a system of economic analysis as distinct from financial profitability analysis.
IFCI adopted a system of economic appraisal in 1979. Finally, IDBI also introduced a
system for economic appraisal of project financed by them. Though there are some
minor variations, the three institutions follow essentially a similar approach, which is
simplified version of the L-M approach.
IDBI, in its economic appraisal of industrial projects, consider three aspects:
Economic rate of return
Effective rate of protection
Domestic resource cost
Economic rate of return
The economic rate of return is the internal rate of return of the stream of social cost &
benefit. The method followed by IDBI to calculate the economic rate of return id a similar
approach, which is a simplified version of L-M approach & is described as follows:
International prices are regarded as economic prices so market price is
substituted with international prices for all non-labour input and output.
For tradable items where international prices are already given CIF prices are
used for inputs & fob prices are used for output.
For tradable items where international prices are not directly available and for
non-tradable items social conversion factors are used to convert actual rupee cost
into social cost.
Generally, the social cost of tradable component is obtained by multiplying it by a factor
of 1/1.5.
Social cost of labour cost is obtained by multiplying it by a factor of 0.5.
Social cost of the residual component is obtained by multiplying it by a factor of 0.5.
Social conversion factors (SCB) or proportion of three components, tradable
(T), labour (L), and residual (R)
Item
SCF or proportions
Land
SCF= 1/1.5
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Indigenous equipment
SCF = 0.70
Transportation
SCF = 1.50
Bank charges
SCF = 0.20
Preoperative expenses
SCF = 1.00
Labour
SCF = 0.50
Salaries
SCF = 0.80
SCF = 1/1.5
Electricity
Domestic stores
SCF = 8.0
Other overheads
SCF = 1/1.5
The data required for calculating the ERP may be arranged as follows:
At domestic prices At world prices
A. Selling price
B. Input cost
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PROJECT MANAGEMENT
Non-traded
C. Value added
The domestic selling price is net of taxes and excise duties but inclusive
of a reasonable selling commission. The selling price at world price is the CIF price for
import and fob for exports.
It may be emphasised that when the value added at domestic prices is same as the
value added at world prices, the ERP is zero. In such a case it implies that a project does
not enjoy any protection from international competition. When the value added at
domestic price is higher than the value added at world price, as is often the case, the
ERP takes a positive value. Clearly the higher the value of ERP, the higher the implied
protection enjoyed by the project. It is generally agreed that the extent of protection
given to a project should not exceed 30 per cent.
Domestic resource cost
The domestic resource cost is calculated as follow -:
Domestic
Imported
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Selling price
Operating costs
Raw materials (net of duties & taxes)
Capital costs
Charge on capital employed
Depreciation
The capital employed consists of fixed assets plus working capital. It is broken down into
indigenous and imported components. After deducting taxes and duties from both the
components, the charge on capital employed is imputed as 10 %.
In case of depreciation capital equipment are split into indigenous and imported
components. After deducting taxes and duties depreciation is taken as 6%.
The relationship between ERP & DRC is -:
DRC = (ERP+1) Exchange rate
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