CE2451 Engineering Economics & Cost Analysis · 2/25/2015 1 dr. m. selvakumar associate professor...

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D R . M . S E LVA K U M A R

A S S O C I AT E P R O F E S S O R

D E PA R T M E N T O F C I V I L E N G I N E E R I N G

S R I V E N K AT E S WA R A C O L L E G E O F E N G I N E E R I N G

CE2451 Engineering Economics & Cost Analysis

Objectives of this course

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The main objective of this course is to make the Civil Engineering

student know about the basic law of economics, how to organize a

business, the financial aspects related to business, different methods of

appraisal of projects and pricing techniques. At the end of this course

the student shall have the knowledge of how to start a construction

business, how to get finances, how to account, how to price and bid and

how to assess the health of a project.

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Unit 3: Organisation


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Forms of business - proprietorship - partnership - joint

stock company - cooperative organisation - state enterprise

- mixed economy - money and banking - banking - kinds -

commercial banks - central banking functions - control of

credit - monetary policy - credit instrument.

U N I T 3

Organisation

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Forms of business

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Forms of Business Organisation

•Business is always owned by someone

•Most of the business aim for PROFIT

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Forms of Business Organisation

•Some are ‘NOT-FOR-PROFIT’ e.g. Non-Governmental Organisations (NGOs)


Example for NGO

Orphanage Homes

Old age homes

M S Swaminathan Research Foundation

Tamil Nadu Kidney Research Foundation

Lions Club, Rotary Club, Blue Cross, Exnora

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Forms of Business

•Sole Trader

•Partnership

•Limited Companies

•Co-operatives

•Franchises

•Public Sector


SOLE TRADER

It is a type of business entity that is owned

Run by one individual

No legal distinction between owner & business

Owner receives all profits

responsible for all losses/debts

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SOLE TRADER


PARTNERSHIP

An arrangement in which parties agree to cooperate

Formed between one or more businesses

Partners share profits & losses

Exist within, and across, sectors

Navigated into an agreement

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According to section 4 of the Partnership Act of 1932 in India, "Partnership is

defined as the relation between two or more persons who have agreed to

share the profits according to their ratio of business run by all or any one of

them acting for all."

PARTNERSHIP ACT


Amazon India has chosen India Post as its primary delivery partner and all “AmazonFulfilled” orders are now being shipped through India Post.

PARTNERSHIP Example

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PRIVATE LIMITED COMPANIES

•Limited by shares

•Means company has ‘shareholders’

•Shares may not be offered to the general public


•Private companies have the suffix "Limited“

• Share holders - close group of friends and relatives

•Can not transfer shares


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PUBLIC LIMITED COMPANIES

•Public Limited, who's owners are Public

•Shares are open to anyone

•Transfer his shares freely

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PUBLIC LIMITED COMPANIES-examples


Cooperatives

•An autonomous association

•Persons voluntarily cooperate for mutual benefit

•consumer cooperative or worker cooperative or housing cooperative)

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•Sugar cooperative societies: Members of the society include farmers,

supplying sugarcane to the mill.

Cooperatives


Other Cooperatives

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BITS Coop Store

A Supermarket, AKSHAY is located at BITS Pilani

Number of student volunteers are working

Earn While You Learn System

General provision, sanitary goods, cosmetics, snacks, books and

stationery, fruits and vegetables at reasonable rates.


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BITS Coop Store


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Principles

Voluntary and Open Membership

Open to all people able to use its services and willing to accept the

responsibilities of membership, without gender, social, racial, political or

religious discrimination


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Autonomy and Independence

Cooperatives are autonomous. Even if enters into agreement with some other

organisation, the autonomy will be maintained.


26Principles

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Educate, Training and Information

Provide education & training for members so they can contribute effectively

for its development.


27Principles


Franchises•Practice of using another firm's successful business model

•Franchisor sells the right to another business (franchisee) to operate

•Pay a proportion of their profits to the franchisor

•Franchiser may provide training, management expertise and national marketing

campaigns

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Franchises: example

Joint Stock Company

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Joint Stock Company

A joint stock company is a business

entity which is owned by share holders.


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Each share holder owns the proportion of

the company in proportion to his/her

ownership of the company’s shares.


32Joint Stock Company

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This allows for the unequal ownership of a business with some shareholders

owing a larger proportion.


33Joint Stock Company

Shareholders vote to accept or reject

annual report/ audited set of accounts


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Joint Stock CompanyAdvantages

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Individual shareholders can sometimes

stand for directorship within the company

(uncommon)


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Joint Stock CompanyAdvantages

Foreign direct investment

Foreign direct investment (FDI) is a direct investment into production or

business in a country by an individual or company of another country,

either by buying a company in the target country or by expanding

operations of an existing business in that country.


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Mixed Economy

“Pure” Command Economies


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If government controlled everything in the economy, then having a diversity

of products would be very difficult.

With no private businesses, there would be no competition, and products

would never improve.

The government could make the economy exploit the poor and benefit the

rich.

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“Pure” Market Economies


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If an economy was pure market, people could sell anything, even things that

could hurt others.

Businesses could make things cost as much as they wanted.

In order to make products cheaper, they could skimp on safety and benefits

for workers.

Most Countries Lie Somewhere in Between-However, they may be closer to one side

than the other.


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Banking


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Definition of a Bank

Banks are like Reservoirs.

They collect the savings of some people and

give them to others who can use them

productively.


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In the process, they earn a commission, out of

which they pay interest to those who save and

deposit funds with them.


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A bank is an institution in which those people

who have spare cash deposit to it and those

who need funds borrow from it.


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Type of Banks

Commercial Banks

Exchange Banks

Industrial Banks

Cooperative Banks

Savings Banks

Central Banks


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Commercial Banks

These Banks play the most important role in

modern economic organisation.

Business mainly consist of receiving deposits,

giving loans and financing the trade of a country.

They provide short-term credits i.e. lend money

for short periods.


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Commercial Banks


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Exchange Banks

Their main function is to discount, accept and

collect foreign bills of exchange. They also buy

and sell foreign currencies and help

businessmen to convert their money they need.

The share in the internal is too small.


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Bill of Exchange: A non-interest-bearing written order used primarily in internationaltrade that binds one party to pay a fixed sum of money to another party at apredetermined future date.

Exchange Banks


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Industrial Banks

Industries require capital for a long period for

buying machinery and equipment.

Industrial banks provide this type of block

capital. Industrial banks have a large capital of

their own.

They also receive deposits for longer period.


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Industrial Banks

Industrial Development Bank of India

Industrial Credit and Investment Corporation of India


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Cooperative Banks

Main business is to provide funds to formers.

Long-term as well as short-term capital is provided.

Long-term is needed for permanent land

improvement and short-term is needed for

purchasing fertilizers/seeds etc.

Function based on cooperative principles.


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Principles

Voluntary and Open Membership

Democratic Member Control

Members’ Economic Participation

Autonomy and Independence

Educate, Training and Information


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Principles

Cooperation and Cooperatives

Concern for Community


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Savings Banks

These banks perform the useful service of

collecting small savings in addition to the

commercial banks.

Post office saving bank is an good example of this

kind.


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Central Banks

Over and above of various types of banks, there

exist in all countries called Central Banks.

It is usually owned and controlled by the

government of the country.


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Reserve Bank of India

RBI is India’s central banking institution, which controls the ‘monetary policy’

of Indian Rupee.

It was established on 1 April 1935.


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Following India’s independence in 1947, the RBI was nationalized in the year

1949.


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The general superintendence and direction of the RBI is entrusted with the

21member Central Board of Directors as given below:


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The Governor (currently Mr.Raghuram Rajan)

Four Deputy Governors

Two Finance Ministry Representatives

Ten governmentnominated directors to represent important elements from

India's economy

Four directors to represent local boards headquartered at Mumbai, Kolkata,

Chennai and New Delhi.


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Functions of Central Banks

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Central Banks

Over and above of various types of banks, there

exist in all countries called Central Banks. It is

usually owned and controlled by the government of

the country.


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Central Banks in India: RBI


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Functions

Monopoly of noteissue

Banker, agent and advisor to the Government

Custodian of cash reserves of commercial banks

Custodian of nation’s reserves of international currencies


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Functions

Lender of the last resort

Clearing house function

Credit control


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Monopoly of note-issue

Noteissue primarily is the main function of a central bank in every country.

These days, in all the countries where there is a central bank generally it has

got the monopoly or the sole right of noteissue.


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As banker to the government, central bank provides all those services and

facilities to the government which public gets from the ordinary banks.

It operates the accounts of the public enterprises.


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It manages government departmental undertakings and government funds

and when there is a need gives loans to the government.


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It accepts the payment of taxes from the public on behalf of the government

and makes payment for the cheques issued by the government.


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Central bank is the bank of banks.

This signifies that it has the same relationship with the nationalized

commercial banks in the country which they have with their customers.


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It provides security to their cash reserves, gives them loan at the times of

need, gives them advice on financial and economic matters and works as

clearing house among various member banks.


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A definite percentage of deposits of commercial banks are kept as reserve

with the central bank.

This leads to centralisation of cash reserve and facilitates working of credit

control.

These funds are of great significance during the time of emergency.


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Custodian of nation’s reserves of international currencies

Central bank is the custodian of the foreign currency obtained from various

countries.

This has become an important function of central bank, these days, because

with its help it can stabilize the external value of the currency.


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Central bank works as lender of the last resort for commercial banks

because in the times of need it provides them financial assistance and

accommodation.


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Whenever a commercial bank faces financial crisis, central bank as lender of

the last resort comes to its rescue by advancing loans and the bank is saved

from being failed.


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Clearing house function

All the commercial banks have their accounts with the central bank.

Therefore, central bank settles the mutual transactions of banks and thus

saves all banks contacting each other individually for setting their individual

transactions, in this way; the unnecessary cash transactions between

individual banks are avoided.


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Credit control

This is a very important function.

These days, the most important function of central bank is to control the

volume of credit for bringing about stability in the general price level and

accomplishing various other socioeconomic objectives.


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Functions of Commercial Banks

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Definition

A commercial bank is a type of bank that provides services such as

accepting deposits, making business loans, and offering basic investment

products.


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Investment Products

Investment products are available for individual and institutional

investors, and are purchased in an attempt to generate a profit.

Some investment products, such as certain types of bonds, provide a fixed

interest payment in addition to a return of the initial investment at the

time of maturity.


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Investment Products

Other types of investment products, such as stocks, entail greater risk and

while earnings (and profits) are anticipated, they are not guaranteed.

An investor who diversifies will have a variety of investment products in

his or her portfolio to manage risk.


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MAIN FUNCTIONS OF COMMERCIAL BANKS


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1. Accepting deposits

The most important function of commercial banks is to accept deposits from

the public.

Various sections of society, according to their needs and economic

condition, deposit their savings with the banks.


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For example, fixed and low income group people deposit their savings in

small amounts from the points of view of security, income and saving

promotion.

On the other hand, traders and businessmen deposit their savings in the

banks for the convenience of payment.


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Therefore, keeping the needs and interests of various sections of society,

banks formulate various deposit schemes. Generally, there are three types

of deposits which are as follows:


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a. Current deposits

The depositors of such deposits can withdraw and deposit money whenever

they desire. Since banks have to keep the deposited amount of such

accounts in cash always, they carry either no interest or very low rate of

interest.

These deposits are called as Demand Deposits because these can be

demanded or withdrawn by the depositors at any time they want.


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a. Current deposits

Such deposit accounts are highly useful for traders and big business firms

because they have to make payments and accept payments many times in a

day.


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b. Fixed deposits

These are the deposits which are deposited for a definite period of time.

This period is generally not less than one year and, therefore, these are

called as long term deposits.

These deposits cannot be withdrawn before the expiry of the stipulated time

and, therefore, these are also called as time deposits.


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b. Fixed deposits

These deposits generally carry a higher rate of interest because banks can

use these deposits for a definite time without having the fear of being

withdrawn.


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c. Savings deposits

In such deposits, money up to a certain limit can be deposited and

withdrawn once or twice in a week. On such deposits, the rate of interest is

very less.

As is evident from the name of such deposits their main objective is to

mobilise small savings in the form of deposits.

These deposits are generally done by salaried people and the people who

have fixed and less income.


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2. Giving Loans

What is LOAN?

In finance, a loan is a debt provided by one entity (organization or individual)

to another entity at an interest rate (%), and evidenced by a note which

specifies, among other things, the principal amount, interest rate, and date

of repayment.


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2. Giving Loans

Typically, the money is paid back in regular installments, or partial

repayments; in an annuity, each installment is the same amount.


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2. Giving Loans

The second important function of commercial banks is to advance loans to

its customers.

Banks charge interest from the borrowers and this is the main source of

their income.


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2. Giving Loans

Banks advance loans not only on the basis of the deposits of the public

rather they also advance loans on the basis of depositing the money in the

accounts of borrowers.

In other words, they create loans out of deposits and deposits out of loans.

This is called as credit creation by commercial banks.


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2. Giving Loans

Modern banks give mostly secured loans for productive purposes. In other

words, at the time of advancing loans, they demand proper security or

collateral (e.g. Pledge gold for money). Generally, the value of security or

collateral is equal to the amount of loan.


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2. Giving Loans

This is done mainly with a view to recover the loan money by selling the

security in the event of nonrefund of the loan.

At limes, banks give loan on the basis of personal security (i.e. third party)

also. Therefore, such loans are called as unsecured loan. Banks generally

give following types of loans and advances:


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i. Cash Credit In this type of credit scheme, banks advance loans to its customers on the

basis of bonds, inventories and other approved securities.

Under this scheme, banks enter into an agreement with its customers to

which money can be withdrawn many times during a year.

Under this set up banks open accounts of their customers and deposit the

loan money. With this type of loan, credit is created.


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i. Cash Credit-example

This kind of fund is provided to traders/manufacturers & the like. Bank has

focus for extending cash credit facility to small & medium size enterprises.

Purpose: Working Capital requirements / Additional stock purchase /

Repayment of trade condition


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i. Cash Credit-example

Rate of Interest

LOAN AMOUNT INTEREST

Below Rs 50 Lacs 13.00%

Rs 50 Lacs To Rs 2 Crore 12.75%

ABOVE Rs 2 Crore 12.25%

Minimum 30% of net inventory

Repayment: Maximum period up to 12 months on renewable basis.


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ii. Demand Loans

Demand loans are loan agreements that provide the lender with the ability

to demand full payment of the remaining balance of the loan at any point in

time after the loan is executed.

Unlike an installment loan, the demand format does not include a specific

maturity date/specific schedule for making payments to retire the debt.


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ii. Demand Loans

Sometimes referred to as a call loan, a demand loan is usually employed

when the lender and borrower have a long standing and positive business

relationship, and the lender has confidence that the borrower will pay off

the loan within a reasonable period of time.


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ii. Demand Loans

A demand loan is often beneficial to the borrower, in that the repayment

schedule is very openended.

This can be especially important if the purpose of the loan was to fund a

new venture that may take some time to become profitable.


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ii. Demand Loans

The borrower may make token payments from time to time as the project

begins to take off, gradually increasing the amount and frequency of the

payments as the generated revenue increases.


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iii. Short-term Loan

These loans may be given as personal loans and entire loan amount is

transferred to the loan account of the borrower.

If you've established a good banking relationship with a banker, he or she

might be willing to provide a shortterm loan (less than a year) to finance

your temporary working capital needs.


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iii. Short-term Loan

Some colleges offer short term loans to students. The borrower must be a

student and must be able to show that the loan can be repaid in a certain

amount of time, i.e. 60 days.


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3. Over-Draft

An overdraft occurs when money is withdrawn from a bank account and the

available balance goes below zero.

In this situation the account is said to be "overdrawn".


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3. Over-Draft

If there is a prior agreement with the account provider for an overdraft, and

the amount overdrawn is within the authorized overdraft limit,

then interest is normally charged at the agreed rate.

If the negative balance exceeds the agreed terms, then additional fees may

be charged and higher interest rates may apply.


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4. Discounting of Bills of Exchange

BILL OF EXCHANGE?

Bills of exchange are similar to checks and promissory notes. They can be

drawn by individuals or banks and are generally transferable by

endorsements.


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The difference between a promissory note and a bill of exchange is that this

product is transferable and can bind one party to pay a third party that was

not involved in its creation.

If these bills are issued by a bank, they can be referred to as bank drafts.

If they are issued by individuals, they can be referred to as trade drafts.


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4. Bill of Exchange


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This is the most prevalent and important method of advancing loans to the

traders for shortterm purposes. Under this system, banks advance loans to

the traders and business firms by discounting their bills. In this way,

businessmen get loans on the basis of their bills of exchange before the time

of their maturity.


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5. Investment of Funds

The banks invest their surplus funds in three types of securities—

Government securities, other approved securities and other securities.

Government securities include both, central and state governments, such as

treasury bills, national savings certificate etc.


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5. Investment of Funds

Other securities include securities of state associated bodies like electricity

boards, housing boards, debentures of Land Development Banks units of

UTI, shares of Regional Rural banks etc.


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6. Agency Functions

Banks function in the form of agents and representatives of their customers.

Customers give their consent for performing such functions. The important

functions of these types are as follows:


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6. Agency Functions

Banks collect cheques, drafts, bills of exchange and dividends of the shares

for their customers.

Banks make payment for their clients and at times accept the bills of

exchange: of their customers for which payment is made at the fixed time.


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6. Agency Functions

Banks pay insurance premium of their customers. Besides this, they also

deposit loan installments, incometax, interest etc. as per directions.

Banks purchase and sell securities, shares and debentures on behalf of their

customers.

Banks arrange to send money from one place to another for the

convenience of their customers.


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Debentures

Debentures have no collateral. Bond buyers generally purchase debentures

based on the belief that the bond issuer is unlikely to default on the

repayment.


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Debentures

An example of a government debenture would be any governmentissued

Treasury bond (Tbond) or Treasury bill (Tbill). Tbonds and Tbills are

generally considered risk free because governments, at worst, can print off

more money or raise taxes to pay these type of debts.


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7. Miscellaneous Functions

Besides the functions mentioned above, banks perform many other

functions of general utility which are as follows:

Banks make arrangement of lockers for the safe custody of valuable assets of

their customers such as gold, silver, legal documents etc.


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Banks give reference for their customers.

Banks collect necessary and useful statistics relating to trade and industry.


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For facilitating foreign trade, banks undertake to sell and purchase foreign

exchange.

Banks advise their clients relating to investment decisions as specialist

Bank does the underwriting of shares and debentures also.


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Banks issue letters of credit.

During natural calamities, banks are highly useful in mobilizing funds and

donations.

Banks provide loans for consumer durables like Car, Airconditioner, and

Fridge etc.


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Letters of credit

Letters of credit are often used in international transactions to ensure that

payment will be received. Due to the nature of international dealings

including factors such as distance, differing laws in each country and

difficulty in knowing each party personally, the use of letters of credit has

become a very important aspect of international trade.


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Letters of credit

The bank also acts on behalf of the buyer (holder of letter of credit) by

ensuring that the supplier will not be paid until the bank receives a

confirmation that the goods have been shipped.


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CE2451 Engineering Economics & Cost Analysis · 2/25/2015 1 dr. m. selvakumar associate professor...

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Transcript of CE2451 Engineering Economics & Cost Analysis · 2/25/2015 1 dr. m. selvakumar associate professor...