PROJECT APPRAISALPROJECT APPRAISAL

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Generation of Ideas

Stimulating Flow of Ideas

SWOT Analysis

Clear Articulation of Objectives

Fostering a conducive culture

Tools for Idea Selection

Porter Model

Life Cycle Theory

Experience Curve

Following factors to be considered:

Reasonableness of cost

Consistency with Govt. regulations

Adequacy of Market

Availability of inputs

Compatibility with the personality of the Promoter

Risk acceptability level

Preliminary Screening of Ideas

Indentify factors

Assign weight to each factor

Rate the factors on a scale

Multiply factor weight and rating

Add the factor scores to arrive at overall rating index

Project Rating Index

Note - For details, refer Chapter 3 of book “Projects – Planning, Analysis Selection, Financing, Implementation and Review “ by Prasanna Chandra

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Market & Demand Analysis

Key Steps in Marketing &

Demand Analysis

Situational Analysis

Collection of Secondary

Information

Conduct of Market Survey

Characterization of market

Demand Forecasting

Market Planning

Fostering a conducive culture

Define the target population

Select the sampling scheme and sample size

Develop the questionnaire

Recruit and train the field investigators

Obtain information as per questionnaire from sample of respondents

Analyze and interpret the information

Steps in Market Survey

Effective demand in past and present

Breakdown of demand

Price

Methods of distribution and sales promotion

Consumers

Suppliers and competition

Government Policy

Characterization of Market

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Market & Demand Analysis

These methods rely on the judgment of experts to translate qualitative information into quantitative estimates. Since its based on the judgment, there is high likelihood that it may go wrong. Following are the important methods:

Jury of Executive Method

Delphi Method

Qualitative MethodsThese methods generate forecasts on the basis of analysis of historical time series.. Following are the important methods:

Trend Projection Method

Exponential Smoothing Method

Moving Averages Method

Time Series Projection Methods

These methods are more analytical than the above mentioned methods. These methods seek to develop forecast based on cause and effect relationship specified in an explicit, quantitative manner. Following are the important methods: Chain Ratio Method

Consumption Level Method

End Use Method

Casual Methods

Leading Indicator Method

Econometric Method

Demand Forecasting

Note - For details, refer Chapter 4 of book “Projects – Planning, Analysis Selection, Financing, Implementation and Review “ by Prasanna Chandra

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Technical Analysis

1. Choice of Technology : Choice of technology is influenced by the following factors: Plant Capacity Principal Inputs Investment Outlay and production costs Use by other units

2. Technical Arrangements : Satisfactory contractual arrangements should be made to obtain the technical know how needed for the proposed production process. Following should be worked out in detail: Price of the technology & mode of payment Process and Performance guarantees

3. Material and Inputs Raw Material Utilities

4. Product Mix: Choice of Product Mix is guided by the market requirements. While planning the production facilities some flexibility in product mix should be sought

5. Plant Capacity : Following factors have bearing on the plant capacity decision: Technological requirement Input constraints Investment costs

Product Mix Latest Developments Ease of absorption

Auxiliary Materials & Factory Supplies Processed Industrial Materials & Components

Period of collaboration & Assistance provided Continuing benefit of R&D work being done

Market conditions Resources of the firm Government Policy

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Technical Analysis

6. Location and Site : Choice of site location is influenced by following factors: Proximity to the source of raw materials Proximity to markets Availability of infrastructure

7. Machineries and Equipment : Requirement of machinery and equipment is dependent on the production technology and plant capacity

8. Structure and Civil Works: This may be divided into 3 categories: Site preparation and Development Buildings and Structure Outdoor Works

9. Environmental Aspects: Following key issues should be considered in respect of environment

What are the types of effluents and emissions generated What needs to be done for proper disposal of effluents and treatment of waste Will the project be able to secure all the environmental clearances

10. Charts and Layouts: Charts and layouts define the scope of the project and provide the basis of detailed engineering and estimation of investment and production costs

Labour Situation Government Policies Other factors like climatic & living conditions

Note - For details, refer Chapter 5 of book Projects – Planning, Analysis Selection, Financing, Implementation and Review by Prasanna Chandra

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Financial Analysis

1. Sources of Finance: Following can be sources of finance for a project: Equity Preference Debentures & Bonds Bank Loan

2. Cost of Capital : : Cost of Debt – Redeemable and Irredeemable Cost of Preference – Redeemable and Irredeemable Cost of Equity – Dividend growth model & CAPM Overall/weighted average cost of capital

3. Investment Evaluation CriteriaDiscounting Techniques Net Present Value Method Profitability Index Internal Rate of Return

4. Estimating Cash-flows: Estimating Cash flows of a normal project Estimating cash-flows of a replacement project

Personal Funds Loans from friends & Relatives Private Equity Venture Capital

Non Discounting Techniques Accounting rate of return Payback Period Method

Note - For detailed notes, refer to a separate handout – FM Section2 and Section3

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Risk Analysis

1. Risk Adjusted Discount Rate (RADR) : In this approach, discount rate of the Project is adjusted for Risk. Higher the risk, higher is the discount rate used for determining the NPV of the Project. Following are the calculation steps Calculate RADR which is = Risk Free Rate of Return + Risk Premium Calculate Present Value of Cash Flows using RADR as discount rate The Project which gives positive NPV, should be selected

2. Certainty Equivalent Quotient (CEQ): In this approach, Cash flows of the project are adjusted for risk instead of the discount rate. Discount rate used is the risk free rate of return instead of weighted average cost of capital. Following are the calculation steps Multiply the Cash Flows with CEQ to find out risk adjusted cash flows Use Risk free rate of return as discounting factor for determining the NPV of the Project The Project which gives positive NPV, should be selected

3. Probability Theory : Since determination of cash flows of a project is based on certain assumptions about future, which is uncertain, therefore this approach assigns a probability or likely hood of occurrence of the cash flows. . Following are the calculation steps Multiply the Cash flows with their respective probability Add the results to calculate total Expected Value (EV) The Project which gives highest EV, should be selected

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Risk Analysis

4. Optimistic, Most Likely and Pessimistic Estimates: In this approach, cash flows under Optimistic, Most Likely and Pessimistic scenarios are analysed. Following are the steps: If it’s a optimistic scenario, then review the maximum cash flows of each project and select the

one which has the highest cash flow. (follow MaxiMax rule) If it’s a pessimistic scenario, then review the minimum cash flows of each project and select the

one which has the highest cash flow. (follow MaxiMin rule)

5. Standard Deviation: In this approach, risk of each project is measured using coefficient of variation. Higher the coefficient of variation(CV), higher is the risk. Following are the calculation steps Calculate Standard Deviation of each project using the following formula

SD = ∑ (X-X)2p Calculate coefficient of variation of each project using the following formula

CV = SD/EV The Project which gives lowest CV hence lower risk should be selected

6. Sensitivity Analysis: Under this approach, sensitivity of NPV of cash flows is examined under various scenarios like increase in costs, decrease in selling price etc. It is then determined as to which factor NPV is most sensitive to.

7. Decision Tree: it’s a diagrammatic presentation of various possible decisions. Each decision is followed by an outcome and for each outcome Expected Value (EV)is calculated . The decision which gives highest EV is selected.

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Project SchedulingProject Scheduling is the process of organising the activities to be under taken in a project , in a logical sequence. Schedule activities can be logically sequenced with proper precedence relationships, as well as leads and lags to support later development of a realistic and achievable project schedule. Project sequencing can be performed using Network diagrams or Gnatt Charts.Network DiagramsNetwork diagrams are schematic displays of the project’s schedule activities and the logical relationships among them, also referred to as dependencies. An example is shown below

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Project Scheduling

Time EstimationThe process of estimating schedule activity durations uses information on schedule activity scope of work, required resource types, estimated resource quantities, and resource calendars with resource availabilities. The inputs for the estimates of schedule activity duration originate from the person or group on the project team who is most familiar with the nature of the work content in the specific scheduleactivity. Generally 3 estimates are obtained for each activity; Optimistic time (to); Most Likely Time (tm);Pessimistic Time (tp)Once the 3 time estimates are obtained, average time is estimated using the following formula:

te = (to + 4tm + tp)/6

Determination of critical pathOnce the network diagram is ready and average time is determined next step is to determine the Earliest Occurrence Time (EOT) and Latest Occurrence Time (LOT) of each activity, and floats. Float is the extra time available to complete an activity. Critical path is the longest path. Critical path is marked by the events which have zero slack

Determination of FloatTotal Float = LOT of succeeding event - EOT of preceding Event - Duration of the activityFree Float = EOT of succeeding event - EOT of preceding Event - Duration of the activityIndependent Float = EOT of succeeding event - LOT of preceding Event - Duration of the activity

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Project SchedulingTools for evaluating SchedulesProgram Evaluation & Review Technique (PERT) – This technique is used for determining variability of Project duration. Variability is measured using standard deviation. Following steps are involved:

Determine standard deviation of duration of each activity on the critical path using the following formula:

SD of activity = (tp - to)/6Determine standard deviation of total duration of critical path on the basis of information obtained in the above step

(Sum of SD of activities on critical path)2

Critical path Method (CPM): The critical path method is a schedule network analysis technique that is performed using the schedule model. While PERT is used for projects characterised by uncertainty, CPM is used for relatively risk free projects. PERT is more probabilistic in nature whereas PERT is more deterministic. Principal focus of CPM is on variations in activity times as a result of changes in resource assignments. The main thrust of CPM analysis is on time cost relationships and it seeks to determine the project schedule which minimises total cost.

Schedule Compression: Schedule compression shortens the project schedule without changing the project scope, to meet schedule constraints, imposed dates, or other schedule objectives. Schedule compression techniques include:

Crashing: Schedule compression technique in which cost and schedule tradeoffs are analyzed to determine how to obtain the greatest amount of compression for the least incremental cost. Crashing does not always produce a viable alternative and can result in increased cost.

Fast tracking: A schedule compression technique in which phases or activities that normally would be done in sequence are performed in parallel. An example would be to construct the foundation for a building before all the architectural drawings are complete. Fast tracking can result in rework and increased risk. This approach can require work to be performed without completed detailed information, such as engineering drawings. It results in trading cost for time, and increases the risk of achieving the shortened project schedule.